Tax Break Advice: Use a Florida Mortgage on a Bigger Home?

Question: My wife and I are in the 33 percent tax bracket. We’re getting the standard tax breaks for owning our home, having a child and making charitable contributions, but we’re getting hit hard with taxes. Do you think we should buy a bigger home to get a bigger tax break?

Answer: Yes, buying a larger and more expensive home can lead to bigger tax breaks. A larger Florida mortgage can translate into a larger mortgage interest deduction. If you pay points for your mortgage - and pay them in cash - you can deduct them. And, who knows, maybe you’ll be really lucky and your property taxes will go up and you’ll get a bigger deduction there as well.

However, remember, the deduction doesn’t eliminate these costs. It just lowers them. So by buying a larger and more costly house you are increasing the amount of money you spend on housing, even after the deductions.

Granted, you are buying an asset that should appreciate in value over the long term, so you will likely be getting a return on the additional money you’re putting into the house. But if you’re going to justify buying more house not on the need for more space or better living quarters but on tax deductions and returns, then you need to consider whether you might do better putting any extra money you have in stocks.

Of course, assessing whether Florida real estate or stocks is a better investment can get fairly complicated. But on a pure return-on-asset basis, stocks have beaten houses pretty handily over the long term, with house prices climbing about 6 percent annually since 1975 versus about 12.5 percent for stocks.

Yes, houses have other benefits, namely, the tax deductions, the exemption of up to $500,000 in gains for married couples, and the fact that you can live in a house. But when you factor in all the costs, houses have a hard time beating stocks.

I want to be clear that I’m not suggesting that buying a house is a lousy investment or that people should rent instead of take out a Florida mortgage loan (although renting often does make more financial sense than buying if you’re planning to stay in the house only a short time.)

But I think it’s important we think realistically about the investment potential of a home. Over the years, we’ve come to think of housing as a can’t-miss investment, the American Dream as the Dream Investment. But even the National Association of Realtors is forecasting a slight decline in house prices for this year.

And after the last run-up in house prices in the late ’80s and early ’90s, house prices in some hot markets like New York and Los Angeles dipped as much as 20 percent and took almost as long as 10 years to regain their peak.

All in all, I believe the primary reason people should own a home is because they enjoy living in it. And while I think owning a home can be a good investment as well - assuming you don’t buy at a market peak and move out within a few years of doing so - I don’t think it makes sense to buy more home than you need because of the tax breaks or investment potential.

SOURCE: Walter Updegrave, Money Magazine senior editor