Just a few thoughts on itemizing and deductions

I know, another boring post about money and taxes, but stick around you might learn something.

The answer to the “should I itemize?” question is actually pretty simple: if you don’t have enough deductions to surpass the standard deduction then you don’t itemize. You take the larger of the two and be done with it because that’s what benefits you the most. Note for the married folks, if you file separately and one of you itemizes then the other has to too.

The standard deduction is great for people with very little to deduct and itemizing is great for people with lots to deduct. Once you get in the situation where your total itemized deductions are close to your standard deduction then things like the mortgage interest deduction aren’t really that valuable. The mortgage interest deduction is touted as one of the benefits of home ownership, but people like me wouldn’t benefit at all from it.

In our situation, if we owned a home we’d have to hand the bank around $6,000 in interest every year and pay $3,000 in property tax to simply break even with the standard deduction. It’s only after the $10,700 threshold that each additional $1 deduction would benefit from itemizing. Even then I’d only be getting about 20% of that back, so what is the benefit of giving away $9,000 a year and then spending $1 to get back $0.20 after that. In the future, the standard deduction will increase with inflation and we’d gradually pay less interest over the life of a mortgage making it less likely that we’d be over the standard deduction. So whenever I hear someone talk about the tax benefits of owning a home, I take it with a big grain of salt.

Most Americans Don’t Itemize on Their Tax Returns gives a pretty good break down of who itemizes. Those individuals with higher incomes have a greater incentive to itemize because the deductions are more valuable as you move up the tax bracket ladder and this is certainly reflected in the itemizing rates.

I did hear about a proposal to add an additional $1,000 to the standard deduction for people with mortgage interest that don’t itemize. Can’t find anything through Google right now so post a link if you know what I’m talking about.

11 Replies to “Just a few thoughts on itemizing and deductions”

  1. Well obviously you wouldn’t want to argue that mortgage interest deductions are the ONLY reason to own a home. It’s simply a perk in my opinion.

  2. I was targeting this as an evaluation of certain tax strategies instead of reasons to own a home. The mortgage interest deduction is always referenced as something beneficial and I had never seen an analysis that was critical of it.

    If you went by what someone in the industry says like Lending Tree, “One of the biggest incentives to owning a home is that the interest you pay on your mortgage is tax-deductible”, you’d only get half the picture. For people who pay someone to do their taxes and have never even set eyes on a 1040, this could be very misleading.

    And sadly when you Google “tax benefits of owning a home” you get industry websites that have a vested interest in selling you a massive loan.

    Our return is going to be even simpler this year so it will be a good for Sarah to learn the ropes with TurboTax.

  3. You said “The mortgage interest deduction is touted as one of the benefits of home ownership, but people like me wouldn’t benefit at all from it.”

    Yes, if you owned a home and were paying mortgage interest, you would benefit from the mortgage interest deduction. The chances of someone only spending $6000 on mortgage interest in Southern California is almost impossible. On our cheaper townhouse we payed closer to $20,000 in interest last year. Unless you’re near the end of the loan’s life, or you’ve got a rinky dink trailer in compton, your mortgage interest will probably put you over the standard deduction.

    Now whether the interest deduction and other values of home ownership outweigh renting is a different discussion, but you can’t say the mortgage interest deduction isn’t beneficial. Is it a HUGE deal that should convince someone to go from renting to owning? No, it’s not, and I think on that we’d agree.

  4. Why do I have to learn the ropes, I have no problem paying someone to do my taxes for me. In this tough financial market I feel like I should contribute where I can and give my old accountant some work. He is really nice, Andrew you should meet him. : )

  5. I underestimated the interest loaded onto the beginning of the loan. 30 year fixed at 5% on $300k would net $14,900 in interest for the first year with a $1,600 monthly payment. By year 24 the interest is down to $5,380 per year.

    A 15 year fixed has similar interest payments at the beginning and ramps down to $5,770 in year 11 so the deduction would be similar.

    So I think my real issue is with the interest on the loan. With that 30 year fixed, interest would be $280k over the life of the loan. The 15 year drops it to $127k, but a decent alternative would be to just pay extra on a 30 year every month with the option of dropping to the regular payment if things get tough. Adding $700 in principal prepayment would match the 15 year monthly payment and reduce total interest to $132k and the length of the loan to 15 years.

    Will have to see where housing prices go. As prices have come down my resistance to buying has lessened after crunching a few numbers. When we got married buying just simply wasn’t an option. Now renting has a bit of an advantage. If prices drop further then it will start to tilt in the buy direction.

  6. Right, the interest over the life of the loan is just scary. I do an extra payment a year, which cuts the life of a 30-year loan by something like 5-7 years.

    With the way prices have dropped we’ll probably owe more than our place is worth when we decide to move. If that’s the case, I actually hope they’ll drop enough that the loan on a new place is low enough that I can float both mortgages (and have the current one mostly covered by a rental income). The idea of shelling out $50-100k just to LEAVE is crappy.

  7. The cost of selling definitely sucks. Commissions and closing costs would normally eat into any appreciation that occurred, but on top of declining prices it is a double whammy.

  8. You’re talking to a guy who went through a couple years of calculus, linear algebra, numerical analysis, statistics, and logic classes. I got a stack of finance and computer books for Christmas. What could possibly be more fun than doing taxes?

    We could have a tax Pepsi Party. Fill out a line of your 1040 and take a sip of Pepsi. I bet my bippy it would be fun.

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