We’ll explore that question thoroughly in this article as we discuss the new tax brackets, the tax law changes and how they impact the tax benefits of homeownership. First here is a table showing the changes to the Standard Deduction, pre-2018 and now:

Source: CMPS Institute.     *Note: Standard deductions change frequently. Consult a CPA for details.

As a result of the Tax Cuts and Jobs Act of 2017, the standard deduction was effectively doubled in 2018 to $12,000 for individuals and $24,000 for married couples.  In 2019, the standard deduction increased to $12,200 and $24,400 respectively.  This new and much larger standard deduction means that many First Time Home Buyers and other homeowners will not have paid enough mortgage interest and property taxes in order to itemize and will instead select the standard deduction.  You would want to ensure your mortgage interest, property taxes and other deductions exceed the standard deduction in order to itemize deductions and use of your mortgage interest and property tax deduction.

State and Local Taxes (SALT) pre-2018 were previously fully deductible from your Federal income tax if you itemized but now they are capped at just $10,000 annually.

Source: CMPS Institute.

You  can take a Federal income tax deduction against the State and Local taxes to include property taxes you pay for your home if you itemize deductions on your tax return.  However, the new tax law places a cap on the amount of deductible State and Local Taxes (SALT) at $10,000 per year.  This part of the new tax law penalizes those who live in high tax States such as Hawaii by further reducing the incentive to itemize.  Ultimately, if your itemized deductions, such as SALT, mortgage interest and property taxes are less than the standard deduction, there is no need to itemize.

Let’s review how the mortgage interest tax deduction works and how it can benefit you.  In the United States, the majority of us pay income taxes and there are different levels of income tax on different levels of income. 

These are the current “marginal tax brackets” based on the different filing types:

    Source: CMPS Institute.     *Note: Tax brackets change frequently. Consult a CPA for details.

If you file your tax returns as married filing a joint tax return and together you earn $200,000 in gross income, then your tax bracket is 24%.  This doesn’t mean that your entire $200,00 income is taxed at 24%, just the amount over $168,401 and up to $200,000.  Your income doesn’t get taxed at the higher level until your income exceeds the starting amount in the next bracket and only that income is taxed at the higher amount.  So, the first $19,400 is taxed at 10%, then the amount earned from $19,401 to $78,950 is taxed at 12%, then the income earned from $78,951 to $168,400 is taxed at 22% and finally the amount earned over $168,401 is taxed at 24%, giving you a “blended” income tax of 18.17% (total income tax of $36,349).

The great thing about deductions, such as the mortgage interest tax deduction, is that it is a discount “off the top” tax bracket.  If you pay $20,000 in mortgage interest this year and $5000 in property taxes, then you’d subtract that from your $200,0000 total income for a $175,000 taxable income amount. 

               $200,000 Income

               -$25,000 Tax Deduction

               $175,000 Taxable Income

That reduction in taxable income by $25,000 is saving you 24% on that full $25,000 resulting in a $6000 tax benefit (24% discount X $25,000).  This means that your after-tax mortgage interest and property tax expense is just $19,000.  We can apply that same tax benefit to show an after tax interest rate:

               4.5% Interest Rate

               – 1.08 Tax Benefit (24% Discount X 4.5)

               3.42% After-Tax Mortgage Interest Rate

The best way to properly calculate this is with this formula:

               1.00

               -0.24 (Express the tax bracket as a decimal)

               0.76 (Multiplier)

Then, you can now use 0.76 as your multiplier to more easily calculate after tax mortgage interest and after tax interest rate.

               Interest Rate X Multiplier = Net After-Tax Rate

               4.5% Tax Deductible Interest Rate

               x 0.76

               3.42% After-Tax Interest Rate

               Interest and Property Tax Expense X Multiplier = Net After-Tax Expense

               $25,000 Tax Deductible Interest and Property Tax Expense

               x 0.76

               $19,000 After-Tax Interest and Property Tax Expense

*Note: taxpayers whose itemized deductions like mortgage interest and property taxes do not exceed the standard deduction would not benefit from these savings. Please reference IRS Publication 501 for more details.

So, is it better for you to buy a home or rent?  The tax savings of homeownership are no longer the same as they used to be an your tax burden may be about the same whether you own or rent due to the increased Standard Deduction and $10,000 cap on SALT.  How about the wealth benefits of owning versus renting?  Is it better to build equity by paying your own mortgage or paying someone else’s mortgage?

In the following Buy vs. Rent Calculator for a typical Oahu 2 bedroom Condo or Townhome, you can see that the monthly payment does exceed the rent you’d typically pay on a monthly basis.  However, over a 10 year period, even if you rented and invested the down payment funds at a rate of 6% annually, you’d still be way ahead at $96,000 additional wealth by owning instead of renting.

In the following Buy vs. Rent Calculator for a typical Oahu 3 bedroom Single Family Home, again the monthly payment does exceed the rent you’d typically pay on a monthly basis with a 10% down payment.  However, over a 10 year period, you’d have accumulated almost $200,000 additional wealth by owning instead of renting.

Both of these scenarios assume that the rents stay the same over that period of time and that the home or condo appreciates at an annual rate of 3%.  This is a conservative estimate as properties on Oahu have averaged 6%+ appreciation over the last 40 years.

If you are thinking that the tax benefits of homeownership will make it worthwhile for you to own, you may want to adjust your goals to the wealth building benefits of homeownership as you may not be able to realize the tax benefits of the mortgage interest and property tax deduction if your standard deduction exceeds your ability to itemize.  The one caveat to that is if you can qualify for the Mortgage Credit Certificate (MCC), which would turbo-charge your tax benefit but is only available to you if you are a first time home buyer.

PLEASE NOTE: THIS ARTICLE AND OVERVIEW IS PROVIDED FOR INFORMATIONAL PURPOSES ONLY AND DOES NOT CONSTITUTE LEGAL, TAX, OR FINANCIAL ADVICE. PLEASE CONSULT WITH A QUALIFIED TAX ADVISOR FOR SPECIFIC ADVICE PERTAINING TO YOUR SITUATION. FOR MORE INFORMATION ON ANY OF THESE ITEMS, PLEASE REFERENCE IRS PUBLICATION 936.