Table 16-5 shows the components of the first-year home dividend for the home in Fishers, Indiana, both as an owner-occupied home or rental property.

TABLE 16-5. Home dividend, owner-occupied or rented.


Here is where these numbers came from.

Rent. It cost $1,250 a month ($15,000 a year) to rent a comparable house. This is the rent savings for a homeowner, the rental income for a landlord.

Mortgage payment. In the summer of 2005, the interest rate on a thirty-year, fixed-rate mortgage was 5.7 percent, and the mortgage payments were $626.83 a month, or $7,522 a year.

Property tax. In Indiana, property-tax rates are set each year to raise enough revenue to pay for government spending. I estimated that the tax rate on this home would be 2.7 percent. Indiana residents are eligible for a $3,000 homeowner exemption if they have a mortgage. They are also eligible for a homeowner exemption of $35,000 or half the value of the house, whichever is less, if the home is the owner’s primary residence. The 2.7 percent tax is levied on the difference between the assessed value and homeowner exemptions: 0.027 ($135,000 – $3,000 – $35,000) = $2,619. Rental properties and vacation homes are not eligible for the larger exemption. So, a landlord pays a property tax of 0.027 ($135,000 – $3,000) = $3,564.

Tax savings. Of the $7,522 in mortgage payments made the first year, $6,120 is interest on the loan and $1,402 is a partial repayment of the amount borrowed. Homeowners can include the $6,120 in interest and the $2,619 in property taxes as itemized deductions on their federal income tax return. In a 28 percent federal income tax bracket, this saves 0.28 ($6,120 + $2,619) = $2,447 in federal income taxes.

Indiana residents do not deduct mortgage interest from their state taxable income, but they are allowed to deduct up to $2,500 of either property taxes or rent from taxable income. Here, the homeowners would be able to deduct $2,500 either way, so there is no net gain or loss in their state income taxes from owning a home instead of renting. (As explained at the end of this appendix, there is no state or federal tax liability or benefit for landlords.)

Insurance. The annual cost of homeowner’s insurance is $508; if the owners were renting, they would pay $174 for renter’s insurance. The difference is $508 – $174 = $334. For a landlord, the cost of rental-property insurance is $612.

Utilities. I assumed that the homeowners would incur the same expenses for their telephone, electricity, gas, and other utilities if they were renting. So, there is no difference here between buying and renting, and there is no cost for the landlord.

Maintenance. I estimated the homeowner’s annual maintenance expenses to be one percent of the value of the house: 0.01 ($135,000) = $1,350. The expense is probably higher if the owner rents the home out instead of living in it. Nonetheless, I initially assumed that the maintenance expense is the same for both so that we can focus on how the home dividend is affected by the fact that the tax laws are different if the owner lives in the home or rents it out.

Adding up all the entries, the bottom line is a home dividend of $5,622 for a homeowner and $1,952 for a landlord.


If you live in your own home, you do not pay taxes on the implicit income—your rent savings. If you rent the home to someone else, you may have to pay taxes on the rental income minus expenses. So we need to list the tax-deductible expenses and calculate the taxes (if any) that need to be paid. These calculations are shown in Table 16-6.

TABLE 16-6. First-year taxable income for a rental home.

Rental income


Interest portion of mortgage payment


Property tax










Taxable income


The interest portion of mortgage payments is tax-deductible. Of the $7,522 in mortgage payments made the first year, $6,120 is interest. The other expenses are the same as in Table 16-5. In addition, a landlord is allowed to claim a depreciation expense for the structure (but not for the land) because the structure will eventually wear out, but the land presumably won’t. I assume the value of the structure is equal to 75 percent of the total value: 0.75 ($135,000) = $101,250. I depreciate the structure straight line over 27.5 years, which means that the structure is assumed to last 27.5 years and to lose 3.636 percent of its initial value each year: 100/27.5 = 0.03636. The annual depreciation expense is consequently 0.03636 ($101,250) = $3,682.

Adding up all the entries, there is a loss for tax purposes. People who are not real estate professionals typically cannot deduct rental losses against other income because the rental property would then be a tax shelter rather than a real business. (There is a “small investor” exception because the law is intended to curtail the use of rental properties as tax shelters by wealthy persons.) Notice that the landlord’s home dividend in Table 16-5 is positive even though there is a loss for tax purposes. This is one reason why the government is concerned about the use of rental properties as tax shelters.

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