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The Buy-and-Hold Connection: Investing Fundamentals Courtesy of the American Homeowner

Jul 20, 2007

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The Returns: Imputed Income

Homeowners also enjoy the income produced by their properties, which, more technically, is the imputed income—an amount that is not necessarily visible in the value of a house, although it does exist. Simply, the imputed income of a home is the amount of money one would have to spend in renting an equivalent residence, had one not owned the home in the first place. Specifically, you can think of this income as the imputed rent. If you own a home and live in it, you essentially act like a renter who is not paying any rent. This sounds like a nice deal, and it is. Under current law, homeowners do not have to report the income attributed to living in their homes, so imputed income is also tax-free. (You also can think in terms of the imputed income that you carry around. If you are an electrician and you rewire your house, you performed a service that has a monetary value and cannot be taxed.)

Imputed income is a valuable thing, and you can get a good sense of this by looking at the contrasting situations of renting and home-owning. Let's say a group of renters spends a quarter of their monthly incomes on rent, and a group of owners spends a quarter of their incomes on mortgages. Let's further assume that members of the two groups earn roughly the same amount and live in comparable houses. Okay, so it's the first of the month, and rent and mortgage payments are due. The renters use their income, which is taxed either paycheck to paycheck or when they file with the IRS, to make their rent payments; those payments are then taxed as income generated by their landlords. Contrastingly, the homeowners can deduct the interest on their mortgage payments when they pay their taxes, while not having to report the imputed rental income that comes with living in their homes. In effect, the homeowners are not paying as high a tax on their home-related income as are the renters.

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