Managing the shared finances of homeownership has got to be one of the least understood and thus most challenging aspects of home (co)ownership. Especially when it comes to the costs that impact your taxes. It's why we've decided to share a short story with you about two friends who changed their lives through shared homeownership.
Meet Alex and Jamie. Two life-long friends who have decided to buy a home together. They live and work in [INSERT CITY] earning $78k and $85k, respectively. After discussing their personal finances and homeownership aspirations (and using the Tomi (Co)Ownership Calculator of course) they determine they can collectively afford a $650,000 home. They both have enough saved to make a $65,000 down payment (aka 20% or $130,000) while the remaining $520,000 will be jointly financed through a traditional 30-year fixed mortgage at 7% interest. Once they close on the home, Jamie and Alex will pay a monthly mortgage of $3,459 or $1,730 per person.
Here's where the benefits of homeownership really start to show up for those who are on their game. Assuming Jamie and Alex split the costs equally, they are not only able to increase their buying power (allowing them to afford a nicer home in a more convenient location) but they each have the right to realize ALL the tax benefits that individual homeowners receive. One of the biggest being the deduction you can claim for the interest you pay on your mortgage.
The mortgage interest deduction is one of the most significant ways to keep more of what you earn. For unmarried (co)owners, this benefit is particularly advantageous as each owner can deduct the interest paid on their portion of the mortgage.
The interest our friends Alex and Jamie are paying in the first year - with a $520,000 mortgage at 7% interest - is $36,400. Gulp. Since Alex and Jamie are splitting the mortgage payments equally, they EACH have the ability to deduct their half ($18,200) of the total interest from their individual tax returns.
FUN FACT: each (co)owner has the ability to deduct up to $750k of interest paid on mortgage debt for qualified residences meaning the deduction can technically be used across multiple properties.
Similar to the mortgage interest deduction, the property tax deduction allows homeowners to deduct state and local property taxes from their federal taxable income. Unmarried (co)owners can each deduct the property taxes paid equal to their ownership interest in the home.
Let's assume the annual property tax on Alex and Jamie’s home is 1.2% of the property's appraised value ie $8,000. In this case, they would both be able to deduct an additional $4,000 on their taxable income.
Between the mortgage interest ($18.2k) and the property taxes ($4k), Jamie and Alex will have reduced their taxable income far exceeding the standard deduction.
Now let's speculate for a moment and assume, after year one, the Alex and Jamie's home has appreciated 5% in value. That means the home is now worth $682,000 which would be an increase of $16,250 per person.
It's not typical for folks to go buying homes every year or two, but when the time comes for Jamie and Alex to eventually sell, the appreciation in their home can add up, especially when you take into account maybe the biggest tax benefit people aren't aware of.
Another major tax benefit homeownership offers is Section 121 of the Internal Revenue Code aka the primary residence sale exemption. This IRS rule allows homeowners to exclude up to $250,000 of capital gains from the sale of their primary residence, provided they have lived in the home for at least two of the five years preceding the sale. Another benefit EACH (co)owner can realize in full.
Going back to our friends Jamie and Alex - After living in the home for five years, Alex and Jamie decide to sell their home. If the home continued to appreciate 5% each year that $650k they initially bought it for would now be worth $830k. And since they have both lived in the home the entire time, neither of them would pay a dollar in taxes on the $90k in proceeds they each realize when they sell (830k sale price - 650k purchase = 180k proceeds / 2 owners = 90k)!
But lets assume Jamie and Alex strike pay-dirt. They bought the right home in the right neighborhood at exactly the right time and the home sold for $1.1m. In this case, both Jamie and Alex would each be able to use the section 121 exemption in it's entirety, and would pay a total of $0 in taxes on their $500k ($250k each) gain!
Take a page out of Alex and Jamie's playbook and run this exact strategy 2-3 times over the next 10-12 years and you can start to see how the savings and gains can shape your financial well-being in a very big way.
The economic landscape has delayed traditional paths to homeownership, but it doesn’t have to prevent you from realizing the benefits of owning a home. Shared homeownership offers significant tax advantages that can make your investment in property (and people) more financially (and socially) rewarding.
By understanding and leveraging the tax breaks that are available to all homeowners (including fractional owners) people like Alex and Jamie can optimize their finances in a way that will pay dividends down the road.
The morale of the story? High home prices shouldn't prevent you and your people from realizing the benefits that long time homeowners have been been using to grow their wealth for decades—you literally can't afford not to.
So don't wait! Book time with us today to find out how shared homeownership might look for you and your people.
