Thursday, December 7, 2017

Breakeven for standard deduction vs itemized deductions

Breakeven for standard deduction vs itemized deductions under new tax bill:

Question One:   A married couple filing jointly is taking out a mortgage on January 1, 2018.   The standard deduction for the married couple is $24,000.   The mortgage interest rate is 4.0 percent.   The couple has non-mortgage interest deductions totaling $7,000.    The loan to value ratio for the house purchase is 90 percent.

What is the value of the home where this married couple is indifferent between taking the standard deduction and taking itemized deductions in 2018?

Solution:  The first step of the problem involves finding the initial balance of a mortgage which results in $17,000 of interest in 2018 when the mortgage is taken out on the first of the year.  The initial balance of a mortgage is an input of the CUMIPMT function.   We need the loan balance that with the other assumptions listed above gives us $17,000 in interest.

This loan balance is found by inputting different loan balance values until we find the one that gives us $17,000 in first year interest.  

The table below indicates the breakeven mortgage is somewhere between $400,000 and $500,000 and is a bit closer to $500,000.


Finding Range for Initial Loan Balance
Interest rate
0.04
0.04
nper
360
360
Loan Balance
$400,000
$500,000
Start Period
1
1
End Period
12
12
Type
1
1
First year Interest
($14,490)
($18,113)


The table below indicates that the initial loan balance that provides $17,000 in interest income is a bit smaller than $470,000.  

Getting Closer to Initial Loan Balance
Interest rate
0.04
0.04
nper
360
360
Loan Balance
$460,000
$470,000
Start Period
1
1
End Period
12
12
Type
1
1
First year Interest
($16,664)
($17,026)

The second step is to calculate the house value.   The mortgage is 90 percent of the house value so the house value is around $470,000/0.9 or $522,222.


Concluding Thoughts:   The analysis presented here indicates that under the S tax bills considered by Congress and under the mortgage assumptions listed here a married couple filing jointly with around $7,000 in non-mortgage deductions and a $522,000 house would be indifferent between taking the standard deduction and itemizing.

 To put this in perspective, the current median U.S. home sales price is around $247,000.

The tax bill currently under consideration by Congress eliminates tax advantages of buying a home for most first-time home buyers.   The key to this result is the doubling of the standard deduction.

A previous policy post showed that the higher standard deduction has a larger impact on home purchases than the abolishment of deductions for state and local income and student loan interest.


Authors Note:   Other financial problems solved with Excel can be found at the following page.


I am moving many of my finance and policy blogs to Word Press.   Go here for free and helpful spreadsheets on mortgage qualification issues.


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