Tax deduction makes buying, not renting, better for some
Should we rent or buy?
Another misunderstood and miscalculated view of housing is fear of lost equity.
Many consumers feel that a risk in purchase during deflation is considered a loss of personal wealth, yet many do not understand the difference in long-term strategy versus short-term cash benefits, even if the market retracts.
How is that possible? Let’s look again at scenarios commonly transacted by consumers to evaluate the truth of purchases in both market trends.
To make it simple, we will again use the $500,000 purchase scenario, where you can divide or multiply the value to estimate your situation or any future opportunity you may be contemplating.
Assume the purchase price is $500,000, and your down payment was $100,000 cash, hard-earned cash. Should the real estate market slide slightly by 5%, the value of the home would be $475,000. Consumers immediately assume their loss is $25,000, and that equates to a 25% reduction in their cash deposited to purchase the residence. Yet there are certain benefits that can soften your worries to understand real estate from a more fundamental view.
The property value declined to $475,000, yet the loan value is still $400,000. The payment, assuming a 5% interest rate, is $2,147.29* per month.
However, the amount of interest is separated over the life of the loan, whereas the payment, although fixed, is adjusted behind the scenes as you progressively make payments.
Therefore, the principal amount of the payment increases as the interest decreases. In our example, the first year the interest is estimated to be approximately $20,000 of the annual $25,767 payment. The interest is tax deductible.
Looking into this deeper, the $20,000 in interest at an estimated 36% tax bracket would create tax relief of about $7,200.
Assuming that this was the tax relief against regular income (36%) the benefit of purchase was still a gain to the homeowner.
The $25,000 reduction in value has now been reduced to $17,800 but here is the real look: If you are not in an immediate hurry to sell, and the value decreased during the first year, your benefits just returned you 7.2% on the $100,000 you invested because you have not sold the house and realized a loss.
So every year you own the home assuming there is no increase in value, you realize this same deduction compounding annual return on investment.
Every year, your $100,000 down payment, invested in real estate returns a benefit, whereas if it were in institutional bank or other investment the return may be less since the loss or gain is only on the amount of cash not the leveraged amount (gross sales price).
By leverage I mean that this scenario introduces deflation, or zero appreciation, but should the home go up 5%, that would be by our example $25,000 upside plus the $7,200 in benefits (tax relief), therefore, in conclusion, the return on an investment down payment of $100,000 is 32.2%, or $32,200.
Remember that your down payment can deflate, but the down payment also supports a top-end appreciation on the entire purchase, not just on the
See VIEW, page C42
