Tax Blog

How to Find Tax Relief: Renting vs. Buying

Buying a home – hands down – provides more tax relief than renting. The government has enacted laws that subsidize home ownership to nudge citizens toward buying and away from renting.

If the federal government is deliberately making it financially advantageous to buy instead of renting, why does anyone rent?

Is buying always the best decision?

No, absolutely not. Sometimes renting makes more financial sense, despite the tax laws. Keep in mind that tax relief should not be your only criteria in deciding whether to rent or buy. Other considerations include how long you plan to stay in an area, if you have enough for a down payment, if you qualify for a loan, and if you can take on the financial and emotional responsibilities that come along with owning real estate.

But if lowering your tax burden is your only criteria in deciding whether to buy or rent, then buying a home makes loads more common sense than renting. Let’s walk through a few examples and a few reasons why.

Why does buying make more sense than renting from a tax perspective?

Let’s imagine, for example, that you are paying $1200 per month for a rental. You will receive no tax benefits relating to your rental when it comes to tax time, nor will your taxes be affected when you move out.

But if you are paying $1200 per month for a home mortgage, you will have multiple possible deductions that will lower your taxable income. Up to $600 of your monthly mortgage payment might be deductible as mortgage interest, and another $1200 or so might be deductible as property tax. In addition, you might be eligible for tax credits if you make qualifying clean energy home improvements or if you are a first-time home buyer. When it comes time to move out, you will sell your home and possibly qualify for another set of positive tax repercussions.

What are deductions? What are credits?

Tax credits affect your taxes directly, while deductions will affect your taxes proportional to your tax rate.

For example, say that you owe $15,000 in taxes in a given year before deductions or credits. If you qualify for a $5,000 credit for installing solar energy panels, you can subtract the $5,000 directly off the $15,000 tax bill, making the total amount owed to the IRS $10,000 total.

In contrast, say that you owe $15,000 in taxes in a given year before deductions or credits. If you are in the 22% tax bracket, that means that your taxable income is approximately $45,000. If you find $5000 worth of deductions, your tax bill will be reduced by 22% of the deduction ($5,000). In this case, the total amount owed to the IRS would be $13,900 total.

In this fictional example, a $5000 tax credit resulted in a tax bill of $10,000, in contrast to the $5,000 tax deduction that resulted in a tax bill of $13,900. Tax credits are subtracted directly from the total amount of taxes owing, while tax deductions are subtracted in proportion to your tax rate.

Why do tax laws favor homeowners over renters?

Home ownership is seen as desirable by the government, so the tax system is deliberately weighted in favor of home ownership. In other words, lawmakers have designed tax laws to encourage and subsidize home ownership for Americans. The reasoning is that home ownership encourages stability, community investment, and helps families build equity, which makes our nation stronger.

To encourage home ownership, the government provides tax breaks in the form of deductions. Deductions lower your taxable income amount and, therefore, lower your overall tax burden. Home-related deductions are offered for mortgage interest, property tax, and private mortgage insurance (PMI). Most homeowners find these three costs (mortgage interest, property tax, and PMI) a substantial amount of money and well worth the time spent to claim the corresponding deductions.

Some analysts argue that mortgage interest deduction has missed the mark because it enables large, long-lasting real estate loans. The 30-year mortgage, which has become the industry standard, is arguably a result of the law that made mortgage interest tax-deductible. In 1913, when Congress passed a law making interest deductible, most people paid cash for their homes. In 2017, approximately a century later, only 29% of homes were bought with cash. Moreover, a high percentage of these cash home sales are initiated by investors.

What are the tax disadvantages of buying?

The only tax disadvantage of buying vs. renting is that your taxes will become more complicated. To claim the tax advantages of buying a home, you will need to itemize your taxes rather than filing the standard deduction. You will need to have records of your property taxes, any qualifying green home improvements. If you are self-filing, plan to tag on an extra few hours to find the relevant documentation and file the corresponding forms. Otherwise, find tax professionals with experience in real estate tax and property transactions.

In conclusion, buying a home will provide more tax relief than renting a home in nearly all situations. (However, tax relief should only be one of many factors that you should consider when deciding whether to buy or rent.) Remember that tax credits are subtracted in full from your tax liability, whereas deductions are subtracted as a percentage based on your tax bracket. Recognize that the government is nudging you toward home buying to promote community stability and individual wealth accumulation. Take advantage of this subsidy by buying rather than renting, all other considerations being equal.