Buying a more expensive house as a tax shelter (larger interest deduction)?
No. This logic is dangerous.  The apples to apples comparison between renting and buying should be between similar living arrangements. One can't (legitimately) compare living in a 600 sq ft studio to a 3500 sq ft house.  With the proposal you offer, one should get the largest mortgage they qualify for, but that can result in a house far too big for their needs. Borrowing to buy just what you need makes sense. Borrowing to buy a house with rooms you may never visit, not a great idea.  By the way, do the numbers. The 30 year rate is 4%. You'd need a $250,000 mortgage to get $10,000 in interest the first year, that's a $312,000 house given an 80% loan. On a median income, do you think it makes sense to buy a house twice the US median?  Last, a portion of the tax savings is 'lost' to the fact that you have a standard deduction of nearly $6,000 in 2012. So that huge mortgage gets you an extra $4000 in write-off, and $600 back in taxes.  Don't ever let the Tax Tail wag the Investing Dog, or in this case the House Dog.  Edit - the investment return on real estate is a hot topic. I think it's fair to say that long term one must include the rental value of the house in calculating returns. In the case of buying of way-too-big house, you are not getting the return, it's the same as renting a four bedroom, but leaving three empty.  If I can go on a bit - I own a rental, it's worth $200K and after condo fee and property tax, I get $10K/yr. A 5% return, plus whatever appreciation. Now, if I lived there, I'd correctly claim that part of my return is the rental value, the rent I don't pay elsewhere, so the return to me is the potential growth as well as saved rent. But if the condo rents for $1200, and I'd otherwise live in a $600 apartment with less space, the return to me is lost. In my personal case, in fact, I bought a too big house. Not too big for our paycheck, the cost and therefore the mortgage were well below what the bank qualified us for. Too big for the need. I paid for two rooms we really don't use. Two points You don't really get the full 10,000 annual interest as tax free income.  Well you do, but you would have gotten a substantial amount of that anyway as the standard deduction. ...From the IRS.... Standard deduction The standard deduction for married couples filing a joint return is at $11,900 for 2012. The standard deduction for single individuals and married couples filing separate returns is $5,950 for 2012. The standard deduction for heads of household increases by $50 to $8,700 for 2012. so If you were married it wouldn't even make sense to claim the 10,000 mortgage interest deduction as the standard one is larger. It can make sense to do what you are talking about, but ultimately you have to decide what the effective interest rate on your mortgage is and if you can afford it. For instance.  I might have a 5% mortgage.  If I am in a 20% tax bracket it effectively is a 4% mortgage to me.  Even though I am saving tax money I am still paying effectively 4%.  Ultimately the variables are too complex to generalize any hard and fast rules, but it often times does make sense. (You should also be aware that there has been some talk of eliminating or phasing out the mortgage interest deduction as a way to close the deficit and reduce the debt.) Depending on the state you live in paying interest on a mortgage opens up other tax deduction options: Real estate taxes, Car tax, donations. See schedule A http://www.irs.gov/pub/irs-pdf/f1040sa.pdf The shocking bottom line is that it never works to your advantage in the short term. Owning your house: But there are big risks, ask anybody stuck with a house they can't sell. But it doesn't scale. You spend 10K more to save 2.5K in taxes. Buy because you want to, not to reduce taxes.
It's rare that you'd start to itemize before you have a house and the property tax and mortgage interest that brings. If your state has an income tax, that's first, but then you'll usually need far more in deductions to be over that standard deduction. "A person can finance housing expenses in one of two ways. You can pay rent to a landlord. Or you can buy a house with a mortgage. In essence, you become your own landlord. That is, insta the ""renter"" pays an amount equal to the mortgage to insta the ""landlord,"" who pays it to the bank to reduce the mortgage. Ideally, your monthly debt servicing payments (minus tax saving on interest) should approximate the rent on the house. If they are a ""lot"" more, you may have overpaid for the house and mortgage. The advantage is that your ""rent"" is applied to building up equity (by reducing the mortgage) in your house. (And mortgage payments are tax deductible to the extent of interest expense.) At the end of 30 years, or whatever the mortgage term, you have ""portable equity"" in the form a fully paid house, that you can sell to move another house in Florida, or wherever you want to retire. Sometimes, you will ""get lucky"" if the value of the house skyrockets in a short time. Then you can borrow against your appreciation. But be careful, because ""sky rockets"" (in housing and elsewhere) often fall to earth. But this does represent another way to build up equity by owning a house." Doom and gloom.  Everything adjusts.  Less tax break here compensated by lower overall tax rates.    Actually, Realtors have less concern with this then you would think.  Those really concerned are bankers.  The financial industry has been messaging Americans for years that mortgage deductions are the best thing in the world.  They are just another way to promote bank loans. It's true that the standard deduction makes the numbers less impressive. I ran your scenario through my favorite, most complete rent vs buy calculator, and your math isn't far off. However, there are a lot of deductions only available if you itemize. Medical expenses, moving expenses, job expenses, charitable contributions, local income/sales taxes, property tax, private mortgage insurance, etc. Property tax on that house alone is going to be nearly equal to the standard deduction, so the point is nearly moot. Anyways, the above linked calculator handles all of those, and more. Should I treat this house as a second home or a rental property on my 2015 taxes? If it was not rented out or available for rent then you could treat it as your second home. But if it was available for rent (i.e.: you started advertising, you hired a property manager, or made any other step towards renting it out), but you just didn't happen to find a tenant yet - then you cannot. So it depends on the facts and circumstances. I've read that if I treat this house as a rental property, then the renovation cost is a capital expenditure that I can claim on my taxes by depreciating it over 28 years. That is correct. 27.5 years, to be exact. I've also read that if I treat this house as a personal second home, then I cannot do that because the renovation costs are considered non-deductible personal expenses. That is not correct. In fact, in both cases the treatment is the same. Renovation costs are added to your basis. In case of rental, you get to depreciate the house. Since renovations are considered part of the house, you get to depreciate them too. In case of a personal use property, you cannot depreciate. But the renovation costs still get added to the basis. These are not expenses. But does mortgage interest get deducted against my total income or only my rental income? If it is a personal use second home - you get to deduct the mortgage interest up to a limit on your Schedule A. Depending on your other deductions, you may or may not have a tax benefit. If it is a rental - the interest is deducted from the rental income only on your Schedule E. However, there's no limit (although some may be deferred if the deduction is more than the income) if you're renting at fair market value. Any guidance would be much appreciated! Here's the guidance: if it is a rental - treat it as a rental. Otherwise - don't. "I think this is possible under very special conditions.  The important part of the description here is probably retired and rich.  The answers so far apply to people with ""normal"" incomes - both in the sense of ""not rich"" and in the sense of ""earned income."" If you sit at the top tax bracket and get most of your income through things like dividends, then you might be able to win multiple ways with the strategy described.  First you get the tax deduction on the mortgage interest, which everyone has properly noted is not by itself a winning game - You spend more than you save.   BUT... There are other factors, especially for the rich and those whose income is mostly passive: I'm not motivated enough on the hypothetical situation to come up with a detailed example, but I think it's possible that this could work out.  In any case, the current answers using ""normal sized"" incomes and middle tax brackets don't necessarily give the insight that you might hope if the tax payer really is unusually wealthy and retired." With an investment, you tend to buy it for a very specific purpose, namely to make you some money. Either via appreciation (ie, it hopefully increases value after you take all the fees and associated costs into account, you sell the investment, realise the gains) or via a steady cashflow that, after you subtracted your costs, leaves you with a profit. Your primary residence is a roof over your head and first and foremost has the function of providing shelter for yourself and your family. It might go up in value, which is somewhat nice, but that's not its main purpose and for as long as you live in the house, you cannot realise the increase in value as you probably don't want to sell it. Of course the remortgage crowd would suggest that you can increase the size of the mortgage (aka the 'home atm') but (a) we all know how that movie ended and (b) you'd have to factor in the additional interest in your P&L calculation. You can also buy real estate as a pure investment, ie with the only objective being that you plan to make money on this. Normally you'd buy a house or an apartment with a view of renting it out and try to increase your wealth both due to the asset's appreciation (hopefully) and the rent, which in this scenario should cover the mortgage, all expenses and still leave you with a bit of profit. All that said, I've never heard someone use the reasoning you describe as a reason not to buy a house and stay in an apartment - if you need a bigger place for your family and can afford to buy something bigger, that falls under the shelter provision and not under the investment. If the mortgage is against your primary residence, then the only part that's (probably) deductible is the mortgage interest.  If you pay down your loan principal faster, then all other things being equal you'll get less of a tax deduction, because you'll accrue less interest in the months after you throw a big chunk at the principal (the principal is less, so the interest is less). But don't worry; that's all right!  It's a tax deduction, so your actual tax savings will be only a fraction of the interest you paid, so at the end of the day you'll be saving yourself money. Those choices aren't mutually exclusive.  Yes, most discussion of the mortgage interest deduction ignores the fact that for a standard itemizer, much, if not all of this deduction can be lost.  For 2011, the std deduction for a single is $5,800. It's not just mortgage interest that's deductible, state income tax, realestate tax, and charitable contributions are among the other deductions. If this house is worth $350K, the property tax is about $5K, and since it's not optional, I'd be inclined to assume that it's the deduction that offsets the std deduction. Most states have an income tax, which tops off the rest. You are welcome to toss this aside as sophistry, but I view it as these other deductions as 'lost' first.  I'm married, and our property tax is more than our standard deduction, so when doing the math, the mortgage is fully deductible, as are our contributions.  In your case, the numbers may play out differently. No state tax? Great, so it's the property tax and deductions you'd add up first and decide on the value the mortgage deduction brings.  Last, I don't have my mortgage for the deduction, I just believe that long term my other investments will exceed, after tax, the cost of that mortgage. There is the underpayment penalty, and of course the general risk of any balloon-style loan. While you think that you have enough self-discipline, you never know what may happen that may prevent you from having enough cash at hands to pay the accumulated tax at the end of the year. If you try to do more risky investments (trying to maximize the opportunity) you may lose some of the money, or have some other kind of emergency that may preempt the tax payment. Your wealth will go up if your effective rate after taxes is less than the inflation rate.  That is, if your interest rate is R and marginal tax rate is T, then you need R*(1-T) to be less than inflation to make a loan worth it.  Lately inflation has been bouncing around between 1% and 1.8%.  Let's assume a 25% tax rate.  Is your interest rate lower than between 1.3% and 2.4%?  If not, don't take out a loan. Another thing to consider: when you take out a loan you have to do a ton of extra stuff to make the lender happy (inspections, appraisals, origination charges, etc.).  These really add up and are part of the closing costs as well as the time/trouble of buying a house.  I recently bought my house using 100% cash.  It was 2 weeks between when I agreed to a price to when the deal was sealed and my realtor said I probably saved about $10,000 in closing costs.  I think she was exaggerating, but it was a lot of time and money I saved.  My final closing costs were only a few hundred, not thousands, of dollars. TL;DR: Loans are for suckers. Avoid if possible. "If this is an issue of opportunity cost then there is a benefit. Mortgage interest rates are extremely low, low enough that they can effectively be used to indirectly fund investments. If one stores equity in a house, ie ""pays it off"", then that wealth returns only the rate of growth of the house less expenditures. If one borrows against the house to fund investments, then the above stated returns which on average exceed the mortgage interest rate can be augmented by the investments, yielding a greater return. The tax benefit is more of a cherry on top. If one is using this as a justification to spend then it is frivolity." "Not sure what you are talking about.  The house isn't part of a business so neither of you can deduct half of normal maintenance and repairs.  It is just the cost of having a house.   The only time this would be untrue is if the thing that you are buying for the house is part of a special deduction or rebate for that tax year.  For instance the US has been running rebates and deductions on certain household items that reduce energy - namely insulation, windows, doors, and heating/cooling systems (much more but those are the normal things). And in actuality if your brother is using the entire house as a living quarters you should be charging him some sort of rent.  The rent could be up to the current monthly market price of the home minus 50%.  If it were my family I would probably charge them what I would pay for a 3% loan on the house minus 50%.   Going back to the repairs... Really if these repairs are upgrades and not things caused by using the house and ""breaking"" or ""wearing"" things you should be paying half of this, as anything that contributes to the increased property value should be paid for equally if you both are expecting to take home 50% a piece once you sell it." A $500K mortgage at 4.5% is $2533, right near the $2500 in your example. Interest the first year would be less than $22K, and your tax benefit (taking littleadv's answer into account, of course) would be $5500, max.  The tax benefit is the least of the reasons to get a mortgage. On your hypothetical $100K income, and too-high mortgage, a $5500 benefit is nothing. If one needs this tax benefit to make the numbers work, they are budgeted too tightly.  If you are considering trading a $1000 rent for a $500K mortgage with a $2500 payment, I'd look very carefully at the numbers. Search this board for the associated expenses of homeownership. That really depends on the lender, and in the current climate this is extremely unlikely. In the past it was possible to get a loan which is higher than the value of the house (deposit considered), usually on the basis that the buyer is going to improve the property (extend, renovate, etc.) and this increase the value of the property. Responsible lenders required some evidence of the plans to do this, but less responsible ones simply seem to have given the money. Here in the UK this was often based on the assumption that property value tends to rise relatively quickly anyway so a seemingly-reasonable addition to the loan on top of the current value of the property will quickly be covered. That meant that indeed some people have been able to get a loan which is higher than the cost of the purchase, even without concrete plans to actively increase the value of the property. Today the situation is quite different, lenders are a lot more careful and I can't see this happening. All that aside - had it been possible, is it a good idea? I find it difficult to come up with a blanket rule, it really depends on many factors -  On the one hand  mortgage interest rates tend to be significantly lower than shorter term interest rates and from that point of view, it makes sense, right?! However - they are usually very long term, often with limited ability to overpay, which means the interest will be paid over a longer period of time.