Homebuyers' Walkthrough: Reasons to Buy
If you’re ready to settle down – and can meet the financial obligations of a mortgage – it might be a good time to become a homeowner. While homeownership involves a serious commitment in terms of finances, time and effort, it has a number of financial and emotional advantages.
Real estate prices are cyclical in nature, but tend to appreciate over time. While most homebuyers can’t expect to quickly buy and sell a home to turn a profit, those who intend to stay in the property for an extended period may benefit from appreciation. (For more, see: Top 4 Things That Determine a Home’s Value.)
While structures like homes depreciate over time, the land underneath the home is what appreciates in value – another example of why "location, location, location" is so important in the real estate industry. Consider this true story: A tiny, run-down house at a popular East Coast beach area was on the market for $1.2 million. The home, which sits on less than a quarter acre, was literally falling apart – it had a crumbling foundation, sagging roof and mold problems throughout – and a new buyer would have to raze the structure (a considerable expense in itself) and pay to build a new house.
Why did this dilapidated home sell for $1.2 million? Location, location, location. The buyer was really buying the land – not the house on it. This property might have sold for even more if the sellers had first razed the home and sold a vacant lot instead. Location, and even a specific location within a neighborhood (such as a cul-de-sac), have a significant effect on value. (For related reading, see: The 5 Factors of a ‘Good’ Location.)
Capital Gains Exclusion
You can exclude up to $250,000 of gain ($500,000 if married filing jointly) on the sale of your home if you meet certain requirements. The maximum exclusion may be claimed if you meet the:
- Ownership requirement: You owned the home for at least 24 months during the last five years leading up to the date of the sale (i.e., the closing date).
- Residence requirement: You lived in the home as a primary residence for at least 730 days (a total of two years) during the five-year period ending on the date of the sale.
- Look-back requirement: You didn’t exclude the gain from the sale of another main home during the two-year period ending on the date of the most recent sale.
If you fail to meet the ownership and use tests – or if you’ve used the exclusion within two years of selling your current home – you may still qualify for a partial exclusion if you can show the main reason you sold the home was a change in workplace location, health issues or an unforeseeable event.
Any losses on the sale of a home are considered a nondeductible personal expense. You can find additional information in IRS Publication 523, "Selling Your Home."
Home equity is the value of ownership built up in a home that represents the difference between the current fair market value of the house and the amount you still owe on the mortgage. Equity builds over time as you pay down the mortgage and the property appreciates in value.
As a homeowner, you build equity in your home as you pay down the mortgage. Part of each monthly mortgage payment is applied to the principal balance of the loan, which reduces the amount you owe – while increasing the equity. Unless you make a huge down payment – or live in a hot real estate market with rapidly rising prices – it will take some time to build equity. In general, if you sell your home during the first few years of the mortgage, you probably won’t have time to build any equity in the property. If you stay longer, however, you’ll start to build a little more equity every month. (See also: The Smartest Way to Tap Your Home Equity.)
Mortgage Interest Deductions
You can deduct the mortgage interest you paid during a tax year on your federal tax return if you meet the following requirements:
- You file Form 1040 and itemize your deductions on Schedule A.
- You are legally liable for the loan (you can’t deduct interest for payments you make on someone else's loan).
- You make the payments on a qualified home.
A "qualified home" can be your main home or a second home. According to the IRS, “A home includes a house, condominium, cooperative, mobile home, house trailer, boat or similar property that has sleeping, cooking and toilet facilities.”
Special tax rules apply to second homes: You can deduct mortgage interest from only one second home, and you must use the property at least 14 days during the year, or more than 10% of the number of days during the year that your home is rented out. If you don’t use the home long enough, it’s considered a rental property – not a second home. (For related reading, see Tax Deductions on Mortgage Interest.)
Interest on a mortgage used to buy, build or improve a home after October 13, 1987, may be fully deducted only if the total debt from all mortgages, including any grandfathered debt, is $500,000 or less if you’re single or married but file separately, or $1 million or less if you’re married and file jointly. [NOTE: This amount will be scaled back to $750,000 on new mortgages if the tax overhaul proposed in late 2017 goes into effect.]
Check out additional information in IRS Publication 936, "Home Mortgage Interest Deduction."
If you move because you start a new job or business, you may be able to deduct your "reasonable" moving expenses, whether you’re self-employed or an employee, if you meet all three of the following IRS requirements:
Your move is closely related to the start of work – both in time and place. To be closely related in terms of time, your move must happen within one year from the date you first reported to work at a new location. Closely related in place means that the distance between your new home and new job is not more than the distance between your old home and the new job.
You meet the distance test. According to the IRS, "Your new workplace must be at least 50 miles farther from your old home than your old job location was from your old home.” If you have no previous workplace, your new job must be at least 50 miles from your old home.
You meet the time test. If you’re an employee, you must work full-time for a minimum of 39 weeks during the first year following your move. If you’re self-employed, you must work full-time for at least 39 weeks during the first year – and a total of 78 weeks during the first two years following your move.
You don’t have to meet the time test if you’re in the Armed Forces and you moved because of a permanent change of station, if your main job was outside the U.S. and you moved back to the U.S. to retire, or if you are transferred for your employer’s benefit or were laid off for a reason other than willful misconduct.
If you meet these requirements, you can generally deduct reasonable expenses for:
- Moving household goods and personal effects (including in-transit or foreign-move storage expenses)
- Traveling to the new home (including lodging but not meals)
- Costs of connecting or disconnecting certain utilities
- Costs for shipping a car and household pets to the new home
It’s important to keep track of all your moving expenses and retain receipts. You can find more information in IRS Publication 521, "Moving Expenses."
Satisfaction of Ownership
The satisfaction of homeownership is a driving force for many homebuyers who want to plant roots, have control over their living spaces and be part of a community. As a homeowner, you have the option to plant gardens, paint, decorate, knock down walls and otherwise make the home your own based on your styles, tastes and preferences. Some people enjoy owning a home for sentimental reasons also, and consider a home a welcoming place to raise a family and create lasting memories.
Property Tax Deductions
Most local governments charge an annual property tax based on the value of real property. You may be able to deduct the tax (or some portion of it) if it’s based on the assessed value of your home and the taxing authority charges the same rate on all properties in its jurisdiction. According the IRS, "The tax must be for the welfare of the general public and not be a payment for a special privilege granted or service rendered to you." Additional information can be found in IRS Publication 530, “Tax Information for Homeowners.” (For more, see: Property Taxes: How They Are Calculated.)Homebuyers' Walkthrough: Buying New vs. Previously Owned