Should your first home be a duplex or a stand-alone home?
Special to the Tribune
Buying your first home can be intimidating and a little bit scary. Consequently, few first-timers explore all of their home buying options and may miss the opportunity to establish a solid foundation for financial health and retirement planning (trust me, it’s never too soon to start planning for retirement).
Instead of buying a stand-alone single family home, consider a duplex and all of its benefits.
Buying a duplex makes it easier to qualify for a mortgage. For example, buying a $400,000 single-family residence (SFR) with a 3.5 percent down payment would require a gross (before taxes and deductions) monthly household income of about $6,200, depending on the buyers’ other debt.
With a duplex, three-quarters of the second unit income is added to the buyers’ income. A $400,000 duplex is likely a pair of two 2-bedroom, 1-bathroom units and one of those units would rent for about $1,700 in our South Lake Tahoe market, based on Craigslist Reno Tahoe. So now you can qualify with a gross income of about $4,700.
Buying a duplex may reduce your income tax exposure. This should not be construed as tax advice — does anybody really know what was in that tax bill that passed last November?
While a duplex owner can deduct mortgage interest expense and property tax in order to reduce taxable income (just like an SFR), they can also file a Schedule E and deduct expenses that would not be deductible in the case of a single family home.
Key among these deductions is depreciation of the second unit. Depreciation is an annual tax allowance for the wear and tear, deterioration, or obsolescence of a property and in the case of a $200,000 unit (one side of our theoretical duplex that is built on land valued at $75,000) the first year depreciation would be $4,545, according to zillow.com.
Assuming a conservative incremental tax rate of 19 percent, the depreciation in this case would reduce your federal tax bill by almost $1,000 just in year one and just in depreciation. Comparable savings would be realized on your state income tax.
Buying and holding a duplex can be an excellent retirement plan. Generally, the more living units in a structure the greater the return on investment. For example, a single family home valued at $400,000 would likely be a three bedroom, two bathroom property that would rent for about $2,300 per month.
Our $400,000 duplex would generate about $3,400 per month in rents and the mortgage payment would be the same for both properties. When you buy your “move up” home you’ll absolutely want to keep the duplex because it has a positive cash flow (making it far easier to qualify for that new home). Eventually, your mortgage will be paid in full, your property tax will be minimal thanks to Proposition 13, and you’ll have the equivalent of a really nice pension.
When you buy that move up home, you may be able to free up cash from the duplex for the down payment.
Buying a duplex makes qualifying for the mortgage easier, may save you money on taxes, and can be an excellent investment.
Sure, everyone dreams of their first home as a cute little place with a white picket fence, but most folks would also probably rather drive a ‘Benz than a hoopty. But thoughtful financial choices early in life will pay huge dividends in the future.
Mark Treiber is with Dignified Home Loans and is licensed in California and Nevada. He can be reached at 530-208-6704.