Why Tax Credits Are So Much Sweeter
Than Tax Deductions
When it comes tax time, most of us really only care about one thing: paying as little as possible without breaking any laws, of course. And while there are great ways to help you buy a house as a first time home buyer, and ways to lower your overall tax burden, not all of these tactics are created equal — which becomes readily apparent as you’re looking over all that IRS paperwork.
In some cases, you may be eligible for a tax deduction whereas in others, you might qualify for a tax credit.
Don’t get me wrong; both are good – Let’s look at the differences!
What Is a Tax Deduction?
Let’s start with the tax-lowering method that’s probably more familiar to you: tax deductions. These work by lowering the total amount of your income that’s subject to income tax.
For example, you can often deduct your contributions to a traditional IRA. So if you make $50,000 in a year, but put $5,000 of it into your traditional IRA, only $45,000 of your income will be taxed — even though you technically made $50,000 total.
Thus, tax deductions save you money by exposing less of your income to taxes. In this case, that last $5,000 would have fallen into the 22% bracket for 2019, which means the deduction saves you $1,100, i.e., 22% of $5,000.
Other common deductions include mortgage interest, charitable donations, property taxes and medical expenses that are more than 10% of your AGI, or adjusted gross income.
What Is a Tax CREDIT?
Now that we’ve got tax deductions squared away,
what about tax credits?
Like tax deductions, tax credits lower your overall tax burden. But rather than reducing how much of your earnings are subject to income tax, tax credits directly reduce your tax bill dollar for dollar.
In short, they’re more powerful than tax deductions… which means they’re also harder to come by and constrained by stricter rules.
That being said, there is one tax credit first time home buyers can use. A first time home buyer is ANYONE that has not owned a property in the last three years. Even if you owned a house more than a few years ago, you would still qualify) The Mortgage Credit Certificate (MCC) is one such program. The MCC program gives you a tax credit of 20% of the mortgage interest you pay in a year. The example below is for a $325,000 purchase price with an interest rate of 4%.
Without an MCC
Annual Income
Mortgage Interest
to deduct
Taxable Income
(assume 15% tax rate)
Federal Income Tax
Total Income Tax Owed
$50,000
$10,000
$40,000
$6,000
$6,000
With an MCC
Annual Income
Mortgage Interest
to deduct (80% total)
Taxable Income
(assume 15% tax rate)
Federal Income Tax
Minus 20% MCC Credit
Total Income Tax Owed
Net gain from MCC
(First Year)
$50,000
$8,000
$42,000
$6,300
($2,000)
$4,300
$1,700
Source: https://www.fdic.gov/consumers/community/mortgagelending/guide/part_2_docs/mortgage_tax_credit.pdf
The annual savings of $1,700 is the same as $167 per month. This is equivalent to getting an interest rate of 3.375%.
A SAVINGS OF .625% IN INTEREST!!!
All you need in Orange County to qualify for this program is to make less than $131,160 for one of two people and be a first time home buyer of an owner occupied condo or house.
Orange County First Time Homebuyers 