Many people are not clear on the tax rules that allow home owners to save money. So here is the first explanation of how owning Real Estate saves you money and creates wealth in a tax advantaged way.
How does the mortgage interest tax deduction work?
For each dollar you pay in interest on your home, you reduce your taxable income by that amount. That is it.
An simplified example: You make $100,000 per year. You pay $50,000 in mortgage interest. Your taxable income is reduced to $50,000.
Compared to renting: If your tax rate is 25%, and you still make $100,000 per year. If you were renting, no matter how much you pay for rent, you will owe $25,000 in taxes to the government. If you instead are paying a mortgage interest payment of $50,000 you would only owe the government $12,500 in taxes.
How do you pay more on your mortgage than you do in rent and save money? Say that you pay $1,000 per month in rent and your tax rate is still 25%. Your $1,000 rent is actually costing you $1,250 after taxes. You could pay this same amount in mortgage interest tax free. So if you instead pay mortgage interest of $1,100 per month, you are saving $150 each month AND you get to own your own home.
Look forward to the next simplified tax lesson on capital gains exclusions and like kind exchanges.
Disclaimer: I am not an accountant. Tax laws change all the time. This law has been in effect for a very long time, but could change or disappear at any time. This is meant only as an informative introduction and you should always follow the advice of a qualified tax accountant.
