For many, a home is the most valuable asset we might ever own. Whether you’re building equity in a primary residence or buying a vacation home or investment property, understanding how to best prepare for, and manage, a real estate purchase is a critical piece of any personal financial plan. In this article, we’ll dive into the many tax and financial considerations of buying and selling real estate, how real estate fits into estate planning, and the role that a wealth manager or financial planner can play in guiding your decision-making.

This article builds upon our series on financial planning, following our other guides, What is a Financial Plan, and How Do I Make One?, and Financial Planning for Estate Planning.

Table of Contents

  1. Buying Your First Home
  2. Tax Considerations for a Primary Residence
  3. Vacation Homes and Investment Properties
  4. How does Real Estate Factor into Estate Planning?
  5. Working with a Wealth Manager or Financial Planner
  6. Harness Wealth Can Help

Buying Your First Home

Generally speaking, a primary residence is the home in which you either spend the most time, or the one to which you are the most connected. Purchasing a primary residence represents a significant financial milestone. If you’re thinking about buying your first home, here are some financial planning considerations to keep in mind:

Preparing for a down payment

For mortgages in the United States, the most common down payment amount is 20%. This can be an unattainable target for many people, given that the median sale price of a home in May 2023 was $416,300, of which 20% would be $83,260.

Fortunately, for first-time home buyers, there are options that can reduce the cost of a down payment:

  1. An FHA loan is a mortgage backed by the Federal Housing Administration and allows for a 3.5% down payment. For a quick example, in the case of a $500,000 home, an FHA down payment would be $17,500 versus $100,000 for a traditional mortgage. FHA loans do have both lower and upper limits, ranging from $472,030 to $1,089,300 for 2023. FHA loans do not have income limits.
  2. A VA loan is a mortgage backed by the US Department of Veterans Affairs and is available only to current or former members of the US military. VA loans generally do not require any down payment, and similar to FHA loans, they do have limits on the total purchase price of the home. VA loans have no limits on the value of the home, and, like FHA loans, VA loans do not have income limits.

Keeping the above options in mind, let’s compare the total purchase price over a 30-year period of a $500,000 single-family home based on a traditional mortgage and an FHA loan.

Traditional Mortgage FHA Loan
Down Payment $100,000 $17,500
Monthly Payment $2,661 $3,210
Total Cost After 30 Years $1,057,960 $1,173,100

Based on an example 7% interest rate

For larger budgets, consider a Pledged Asset Line

If you are considering a home that could be too expensive for an FHA loan, and you don’t qualify for a VA loan, there are still ways to reduce the size of—or eliminate the need for—a down payment. One popular method for that is the pledged asset line.

A PAL is a type of loan that allows you to borrow against your investment portfolio without having to liquidate any assets, which subsequently allows you to avoid incurring any capital gains taxes. This can be particularly attractive to those with large investment portfolios who wish to purchase a more expensive home.

PAL Example for a $2,000,000 home

Let’s consider an example where a potential homebuyer has a $3,000,000 investment portfolio. Most PALs allow for 70% of the portfolio size to be borrowed, giving this individual access to a loan of $2,100,000. As you can see in the below example, this method would allow for no down payment on the purchase of a $2 million home.

Initial Down Payment $0 (loan covers cost)
Monthly Payment $13,982
Total Cost of Home After 30 Years $5,033,520

Based on an example 7% interest rate

The downside to be aware of with a pledged asset line is that there is no fixed maturity date, meaning that your lender can demand repayment in full at any time. To account for this, you could consider using a PAL for the initial purchase of your home, then refinancing it with a traditional mortgage lender. This strategy will allow you to spread out payments over a standard 15 to 30-year mortgage period, while still enabling you to avoid a down payment. 

Tax Considerations for a Primary Residence

Once you purchase your first home, you’ll start to face many costs associated with home ownership. Fortunately, the IRS has a number of tax deductions available, including:

Mortgage Interest Deduction

The Home Mortgage Interest Deduction allows homeowners to deduct mortgage interest on their primary residence from their taxable income. Under the Tax Cuts and Jobs Act (TCJA), and per IRS guidelines, the deduction limit applies to the first $750,000 in mortgage debt for the 2023 tax year, or $375,000 if married filing separately. The deduction can go as high as $1 million, or $500,000, if married filing separately, pending that the mortgage interest was incurred before December 16, 2017.

You can use this guide from the IRS to help determine how much, if any, of your mortgage interest can be deducted from your taxable income.

Personal Property Tax Deduction

The IRS also allows for the deduction of personal property taxes on a primary residence, up to $10,000 for the 2023 tax year, or $5,000 if married filing separately. However, be aware that this $10,000 limit applies to the total amount of your state and local taxes, including income, sales, and property tax, combined.

Home Energy Tax Credits

If you make any improvements to your home that relate to sustainable or renewable energy, you may be eligible for a tax credit under the following two programs:

  1. The Energy Efficient Home Improvement Credit offers a 30% tax credit up to a maximum of $1,200 for qualifying expenses, including exterior doors, windows, skylights, central air conditioners, home energy audits, and more.
  2. The Residential Clean Energy Credit offers a 30% tax credit with no maximum or lifetime limit on qualifying expenses, including solar, wind, or geothermal power generation, solar water heaters, fuel cells, or battery cells.

Tax Credits when Selling Your Primary Residence

If you sell your primary residence, you may qualify for an IRS Section 121 capital gains tax exclusion of up to $250,000 for the 2023 tax year, or up to $500,000 if filing jointly with a spouse. To be eligible, you’ll need to have used the house as your primary residence for at least two years out of the five years leading up to its sale date. Additionally, you must not have already claimed this exclusion on a previous primary residence within the last two years. The Section 121 Exclusion differs from a 1031 Exchange, which applies to property held for business or investment purposes.

Vacation Homes and Investment Properties

Many of us dream of owning a vacation home or a second residence someday. They can offer tremendous opportunities for wealth creation over time, as well as the potential for rental income.

Tax Considerations for Vacation Homes

Owning a vacation home comes with certain tax implications:

Tax Considerations for Investment Properties

Some tax considerations related to investment properties include:

Understanding the specific tax considerations of owning vacation and investment properties can help you optimize your financial plan and minimize your tax burden. As the tax rules are complex and continually changing, it’s advisable to work with a Harness Tax Advisor or other tax professional or advisor who can guide you in navigating these regulations.

IRS Tax Forms for Investment Properties

There are many tax forms that you’ll encounter if you own investment properties. Here are a few to get you started:

How does Real Estate Factor into Estate Planning?

A family home can hold tremendous sentimental value, but when it comes to taxes, passing down real estate to the next generation is not as simple as just handing over the keys.

Real estate is an asset commonly held by an individual’s estate, and taxes may apply to the transfer of an estate to its beneficiaries. At the federal level, estate taxes apply when the value of the estate exceeds $12.9 million. Twelve states impose their own separate estate taxes, with thresholds going as low as $1 million in 2023.

For those estates with high-value real estate and other assets, there are several ways to minimize taxes owed. Here are two common strategies to consider:

Working with a Wealth Manager or Financial Planner

When you’re saving for a down payment or building a real estate portfolio, it could make sense to work with a wealth manager or financial planner.

A financial planner can help you create a roadmap for purchasing your first home, or help you understand if purchasing a vacation home is something you might be capable of.

A wealth manager, on the other hand, can actively manage your assets and investments for you, taking work off of your plate when it comes to the tax and financial intricacies of managing property.

No matter your unique financial situation, seeking professional help for a large purchase can be a smart decision, and it can potentially save you on taxes in both the short and long term.

Harness Wealth Can Help

For many of us, a home is the most valuable asset we’ll ever own. At Harness Wealth, we understand the importance of protecting personal assets, and effectively incorporating them into a comprehensive financial plan. Our experienced team of financial planners and wealth managers can work closely with you to understand your financial situation, goals, and risk tolerance to provide a personalized plan that aligns with your aspirations. If you need help building a personalized financial plan, get started with Harness Wealth today.

Great advisors strive to build your confidence when making important financial decisions. Find yours.

Tax services provided through Harness Tax LLC. Harness Tax LLC is affiliated with Harness Wealth Advisers LLC, collectively referred to as “Harness Wealth”. Harness Wealth Advisers LLC is an internet investment adviser registered with the Securities and Exchange Commission (“SEC”). Harness Wealth Advisers LLC solely acts as a paid promoter for unaffiliated registered investment advisers. Harness Wealth Advisers LLC’s registration as an investment adviser with the SEC does not imply a certain level of skill or training.

This document should not be considered tax, legal or financial planning advice. It does not constitute advice or a recommendation or offer to sell or a solicitation to deal in any security or financial product. It is provided for information purposes only. To the extent that the reader has any questions regarding the applicability of any specific topic discussed above, please consult a tax, legal and/or financial professional for advice specific to your individual circumstances.