buy or rent a home

Should I Buy or Rent a Home?

The concept of home ownership seems to be entrenched in the psyche of Americans, and most people consider owning a home as one of the best ways to accumulate wealth. Moreover, for most Americans, housing represents their largest financial expense. As such, it is not surprising that the question, “Should I buy or rent a home?” is highly relevant for many. To make an informed decision, it is crucial to thoroughly evaluate the factors influencing whether purchasing or renting a home aligns with your specific circumstances while also understanding that home ownership has tax benefits.

What are the tax implications of buying a home?

There are several tax benefits to owning a home. Tax deductions can reduce taxable income on your federal tax return and lead to lower taxes.

  • Property Tax Deduction: Homeowners can deduct property taxes paid to state and local governments. There is currently a $10,000 cap on this deduction as a result of the 2017 Tax Cuts and Jobs Act (“TCJA”). The TCJA is scheduled to sunset at the end of 2025, which could increase this benefit for those in high property tax areas.
  • Mortgage Interest Deduction: A significant tax benefit of homeownership is the ability to deduct the interest paid on mortgages. Since 2017, interest deductions are allowed on mortgage debt up to $750,000 for married filing jointly (but half of that, or $375,000, if married filing separately.) Mortgages originated before December 16, 2017, may qualify for a higher limit of $1 million if married filing jointly ($500,000 if married filing separately).

The TCJA also significantly increased the standard deduction, which resulted in fewer taxpayers itemizing deductions on Schedule A thereby reducing or eliminating the value of the mortgage interest deduction.

  • Capital Gains Exclusion: When you sell your primary residence, you may be eligible for a capital gains tax exclusion of $250,000 per person. A married couple filing jointly would enjoy a $500,000 capital gains exclusion.  If they purchased their home for $500,000 and sold it five years later for $1,000,000, they would not pay federal capital gains. There are some conditions that must be met regarding how long you’ve owned the home and if it has been your primary residence for two out of the last five years.

Considerations for buying vs. renting:

By far, one of the most important considerations in whether to buy or rent is how long the buyer plans to be in the home: longer timeframes favor buying, while a short time horizon generally points to renting. There is a higher probability that your investment will be a positive one if you have owned your residence for over five years. Remember to factor transaction costs for both the purchase and sale in your calculation. These costs include realtor fees, local transfer taxes, and legal expenses, to name a few. The longer you own the home, the more years over which you can spread these costs.

Individual market conditions might also alter the traditional decision to rent or buy. Supply (inventory), health of the local economy, employment opportunities, demographics, and schools can all drive home prices in a particular community. Understand the current environment and underpinnings before plunging into a purchase.

Anyone reading this likely knows that the dramatic increase in interest rates over the last year has meant higher mortgage rates for prospective buyers. The cost to own a home as a percentage of income is nearing all-time highs, making it more difficult to take advantage of homeownership and putting increased pressure on rental markets.

However, there are additional reasons to consider buying and some factors that support renting.

Pros for Buying

  • Forced savings: Your monthly mortgage payment is comprised of interest expense and principal reduction. Reducing the principal on your mortgage equates to building equity in your home. Assuming your mortgage payment is similar in size to what you were paying for rent, the principal reduction could be considered forced savings.
  • Appreciation: When we buy a home, not only are we buying a place to live, but we are also hopeful that the value will increase. As with any investment, there are no guarantees, but appreciation is an incentive to own.
  • Ability to make changes: When you own your home, you have the ability to make upgrades to the home for your own enjoyment, and these upgrades may increase the value of your property, building equity. Some owners may choose to enhance the value of their property through sweat equity by making the improvements themselves.
  • Inflation hedge: In general, real estate tends to rise with inflation and can be a good inflation hedge. In particular, if you have a fixed mortgage, one component of your housing costs will remain constant, while costs around you (including house values) may increase.
  • Greater Inventory: Generally speaking, there is a greater inventory of homes to buy than rent in most markets, providing you with more selection.

Pros for Renting

  • Flexibility: If you’re unsure where you see yourself in a few years, rental decisions are more short-term, allowing you to move every year if desired. We often recommend renting for a year if you are moving to a new part of the country, so you can get a chance to know the area better and make sure you are happy there before buying.
  • Avoids large outlays for repairs or maintenance: While your landlord can certainly raise your rent, you will avoid what can be unexpected homeowner surprises (e.g., roof replacement, broken furnace).
  • No downpayment needed: Although new homebuyers may be able to manage the monthly mortgage payment, many struggle to save enough for a down payment, which is generally 5-20% of the value of the home. Landlords do expect first and last month’s rental payment, but that is significantly less to save.
  • No depreciation risk: While your rent can increase, you won’t lose money on buying a house whose market value drops.

As with most things, each individual or family’s circumstances must be considered when making this challenging decision. It is impossible to categorically state that renting or buying is the better option for procuring a roof over your head.

By weighing each of these factors carefully, you will come to a decision that is right for your unique situation and answers the question, “Should I buy or rent a home?”

Jennifer Nicasio, CFP®
Jennifer joined HTG in 2005. As an advisor, she helps clients make thoughtful and informed decisions on all aspects of their finances. Jennifer is a CERTIFIED FINANCIAL PLANNER™ practitioner and Certified Divorce Financial Analyst®. As a CDFA™ professional, she helps clients understand the short and long-term implications of decisions they are making during the divorce process. Jennifer has a BA from Middlebury College.
The information provided is for educational and informational purposes only and does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor’s particular investment objectives, strategies, tax status or investment horizon. You should consult your attorney or tax advisor.
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