RENTING VS. BUYING Effect of the Standard Deduction

RENTING VS. BUYING

Effect of the Standard Deduction

On casebook pages 339-341, Adam is considering purchasing a home for $175,000, paying $35,000 down and obtaining a mortgage loan for $140,000 at 5%. The principal and interest payments will be $751.55 per month of which $583 initially represents deductible mortgage interest. Alternatively, he is considering renting a home for $750 per month. He is in the 28% tax bracket.

The analysis on page 341 computes the "after-tax" cost of the mortgage payment, noting that most of the mortgage payment is tax deductible. However, the fact that mortgage interest and real property taxes are deductible does not necessarily mean the individual will save a substantial amount of tax.

Adam will pay $6,953 of mortgage interest and $2,066 of principal the first year. Assume he pays $2,400 per year in deductible real estate tax. He will have $9,353 of itemized deductions attributable to his home ownership (interest and taxes). If he is in the 28% tax bracket, he might assume that the deductions will save him $2,619 of tax ($9,353 x 28%).

However, if he rented a home, he would deduct the $5,350 standard deduction instead of $9,353 of itemized deductions. The itemized deductions reduce his taxable income by only $4,003 more than the standard deduction ($9,353 itemized - $5,350 standard). The $4,003 reduction of taxable income saves Adam only $1,121 of tax in the 28% bracket. (If Adam were married, the standard deduction would have been $10,700, and he would have received no tax benefit from the $9,360 of itemized deductions attributable to home ownership.) Furthermore, he is losing interest on the $35,000 down payment for the home.

Rent vs. Buy Calculator Does Not Consider the Standard Deduction

A sophisticated "rent vs. buy" calculator is available online at (click calculators, then click "rent vs. buy" on the left side of the page). This calculator considers factors such as expected after-tax return on the $35,000 down payment that will not be invested, an inflation rate, future value of the home, brokerage commission when the home is sold, closing costs, and the cost of homeowners' insurance.

I entered Adams information in the calculator. The first $951.34 mortgage payment consists of $583.33 deductible interest, $200 deductible property tax, and $168.22 nondeductible principal payment. The calculator assumes the tax savings will be $219.33 ($783.33 x 28%), which does consider the effect of the standard deduction discussed above. The calculator's analysis is on the next page. Note the payment after tax savings for the first month at the bottom of the page is $734.27.

Other Advantages of Home Ownership

Of course there are many financial advantages of owning a home, including the probability of appreciation and the $250,000 or $500,000 exclusion of gain when the home is sold. The point is that potential homeowners should determine the accurate tax savings from the mortgage and interest deductions, after allowing for the standard deduction.

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RENT vs. BUY CALCULATOR ANALYSIS

Your home purchase breaks even after 1.6 years. This is based on your home's equity minus a 5.00% sales commission paid to brokers or real estate agents when you sell your home. It also assumes your home will appreciate at 3.00% per year and you have an income tax rate of 28.00%. If you cannot remain in your home for at least 1.6 years you should consider continuing to rent.

We calculated your breakeven point by examining how long it would take to create enough equity in your home to exceed the value of investing your cash on hand. We also accounted for differences in your monthly rent and house payments. If your rent payment is less than your net house payment, we add that monthly savings to your investment. If your house payment is less than your rent payment we subtract that amount from your investment. You may notice that on the schedule at the bottom of this report the investment value can be reported as negative. This happens if your house payment is significantly lower than your rent payment. It illustrates that if you continue to rent the extra cost of renting would, in effect, use up your cash on hand.

Loan Information

Your total monthly payment was calculated as $951.34. Your down payment was calculated as $35,000 and you had a home price of $175,000. This is for a 30 year mortgage at 5.000% in the amount of $140,000. Total closing costs for this loan are estimated at $0.00. Your current monthly rent is $750. The expected inflation rate of 3.00% annually was used to estimate future rent and property taxes. The rate of return use for investments was 5.00% per year after taxes.

Your $951.34 monthly payment consists of:

Principal and interest PMI Taxes Insurance Association dues & maintenance

$751.55 $0.00 $199.79 $0.00 $0.00

Closing costs of $0.00 consists of:

Amount paid of points Origination fee Other closing costs

$0.00

0$ 0 $

Analysis of Future Payments

House Year Payment (PITI) 1 $951.34 2 $957.34 3 $963.51

Payment After Tax Savings $734.27 $741.11 $748.21

Rent Value of Payment Investment $750.00 $36,543 $772.50 $37,971 $795.68 $39,271

Home Equity $33,303 $40,611 $48,185

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Illinois Association of REALTORS RESIDENTIAL REAL PROPERTY DISCLOSURE REPORT

NOTICE: THE PURPOSE OF THIS REPORT IS TO PROVIDE PROSPECTIVE BUYERS WITH INFORMATION ABOUT MATERIAL DEFECTS IN THE RESIDENTIAL REAL PROPERTY. THIS REPORT DOES NOT LIMIT THE PARTIES RIGHT TO CONTRACT FOR THE SALE OF RESIDENTIAL REAL PROPERTY IN "AS IN" CONDITION. UNDER COMMON LAW SELLERS WHO DISCLOSE MATERIAL DEFECTS MAY BE UNDER A CONTINUING OBLIGATION TO ADVISE THE PROSPECTIVE BUYERS ABOUT THE CONDITION OF THE RESIDENTIAL REAL PROPERTY EVEN AFTER THE REPORT IS DELIVERED TO THE PROSPECTIVE BUYER. COMPLETION OF THIS REPORT BY SELLER CREATES LEGAL OBLIGATIONS ON SELLER THEREFORE SELLER MAY WISH TO CONSULT AN ATTORNEY PRIOR TO COMPLETION OF THIS REPORT.

Property Address:_____________________________________________________________________________ City, State & Zip Code_________________________________________________________________________ Seller's Name:________________________________________________________________________________

This report is a disclosure of certain conditions of the residential real property listed above in compliance with the Residential Real Property Disclosure Act. This information is provided as of _______________, 20_____, and does not reflect any changes made or occurring after that date or information that becomes known to the seller after that date. The disclosures herein shall not be deemed warranties of any kind by the seller or any person representing any party in this transaction. In this form, "am aware" means to have actual notice or actual knowledge without any specific investigation or inquiry. In this form a "material defect" means a condition that would have a substantial adverse effect on the value of the residential real property or that would significantly impair the health or safety of future occupants of the residential real property unless the seller reasonably believes that the condition has been corrected. The seller discloses the following information with the knowledge that even though the statements herein are not deemed to be warranties, prospective buyers may choose to rely on this information in deciding whether or not and on what terms to purchase the residential real property.

The seller represents that to the best of his or her actual knowledge, the following statements have been accurately noted as "yes", (correct), "no" (incorrect) or "not applicable" to the property being sold. If the seller indicates that the response to any statement , except number 1, is yes or not applicable, the seller shall provide an explanation, in the additional information area of this form.

YES NO N/A 1. _____ ____ ____ 2. _____ ____ ____ 3. _____ ____ ____

4. _____ ____ ____ 5. _____ ____ ____ 6. _____ ____ ____ 7. _____ ____ ____ 8. _____ ____ ____

9. _____ ____ ____ 10. _____ ____ ____ 11. _____ ____ ____ 12. _____ ____ ____ 13. _____ ____ ____ 14. _____ ____ ____ 15. _____ ____ ____ 16. _____ ____ ____

17. _____ ____ ____

18. _____ ____ ____ 19. _____ ____ ____ 20. _____ ____ ____ 21. _____ ____ ____ 22. _____ ____ ____

Seller has occupied the property within the last 12 months. (No explanation is needed.) I am aware of flooding or recurring leakage problems in the crawlspace or basement. I am aware that property is located in a flood plain or that I currently have flood hazard insurance on the property. I am aware of material defects in the basement or foundation (including cracks and bulges). I am aware of leaks or material defects in the roof, ceilings or chimney. I am aware of material defects in the walls or floors. I am aware of material defects in the electrical system. I am aware of material defects in the plumbing system (includes such things as water heater, sump pump, water treatment system, sprinkler system, and swimming pool). I am aware of material defects in the well or well equipment. I am aware of unsafe conditions in the drinking water. I am aware of material defects in the heating, air conditioning, or ventilating systems. I am aware of material defects in the fireplace or woodburning stove. I am aware of material defects in the septic, sanitary sewer or other disposal system. I am aware of unsafe concentrations of radon on the premises. I am aware of unsafe concentrations of or unsafe conditions relating to asbestos on the premises. I am aware of unsafe concentrations of or unsafe conditions relating to lead paint, lead water pipes, lead plumbing pipes or lead in the soil on the premises. I am aware of mine subsidence, underground pits, settlement, sliding, upheaval, or other earth stability defects on the premises. I am aware of current infestations of termites or other wood boring insects. I am aware of a structural defect caused by previous infestations of termites or other wood boring insects. I am aware of underground fuel storage tanks on the property. I am aware of boundary or lot line disputes. I have receive notice of violation of local, state, or federal laws or regulations relating to this property, which violation has not been corrected.

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Note: These disclosures are not intended to cover common elements of a condominium, but only the actual residential real property including limited common elements allocated to the exclusive use thereof that form an integral part of the condominium unit.

Note: These disclosures are intended to reflect the current condition of the premises and do not include previous problems, if any, that the seller reasonably believes have been corrected.

If any of the above are marked "not applicable" or "yes", please explain here or use additional pages, if necessary: _______________________________________________________________________________________________ ___ _______________________________________________________________________________________________ ___ _______________________________________________________________________________________________ ___

Check here if additional pages used:________

Seller certifies that seller has prepared this statement and certifies that the information provided is based on the actual notice or actual knowledge of the seller without any specific investigation or inquiry on the part of the seller. The seller hereby authorizes any person representing any principal in this transaction to provide a copy of this report, and to disclose any information in the report, to any person in connection with any actual or anticipated sale of the property.

Seller:_______________________________________________________Date:______________________________ ____

Seller:_______________________________________________________Date:______________________________ ____

PROSPECTIVE BUYER IS AWARE THAT THE PARTIES MAY CHOOSE TO NEGOTIATE AN AGREEMENT FOR THE SALE OF THE PROPERTY SUBJECT TO ANY MATERIAL DEFECTS DISCLOSED IN THIS REPORT ("AS IS"). THIS DISCLOSURE IS NOT A SUBSTITUTE FOR ANY INSPECTIONS OR WARRANTIES THAT THE PROSPECTIVE BUYER OR SELLER MAY WISH TO OBTAIN OR NEGOTIATE. THE FACT THAT THE SELLER IS NOT AWARE OF A PARTICULAR CONDITION OR PROBLEM IS NO GUARANTEE THAT IT DOES NOT EXIST. PROSPECTIVE BUYER IS AWARE THAT HE MAY REQUEST AN INSPECTION OF THE PREMISES PERFORMED BY A QUALIFIED PROFESSIONAL.

Prospective Buyer:________________________________________________Date:__________Time:______________

Prospective Buyer:________________________________________________Date:__________Time:______________

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