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13 Jul 2008

Common Sense…Senseless

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by Jesse Mecham

There is a bit of “conventional” wisdom out there that I just don’t understand. I take that back. I understand it. I just don’t understand how seemingly intelligent people subscribe to it. It is even touted by CPAs and Financial Advisors as great advice. The idea is that it is good to get or keep a mortgage because it is a tax write-off.

I have lost track of the number of people that have told me that the reason they are not paying off their mortgage is because it is a tax deduction. Another comment closely related to that on is when people buy things for their business that they don’t really need because it is a tax write-off. It has to just be an excuse to spend the money, or a convenient justification in their minds, because it just doesn’t make sense to me.

So Let Me Get This Straight

Here is an example. A client came to me a little while back and he said that he planned to take out a much larger mortgage on his house. When I inquired why he explained to me that his CPA had told him that he needed more deductions to get his tax bill lower. The CPA suggested taking out a much larger loan on his home and showed him how much he would save on his taxes.

“So,” I said, “you are going to pay $10,000 more per year in interest to the bank so that you can pay $3,000 less to the government in taxes? You must really, really hate paying money to the government!” Why on earth would someone put themselves $7,000 more in the hole to avoid taxes? It seems like they are taxing themselves more in the process.

I’m All for Paying Fewer Taxes

Don’t get me wrong. I have no desire to pay more taxes. I try to find every honest way to save my clients tax dollars and help them keep what they earn. But I wouldn’t suggest that they spend more than the tax savings in order to get those savings.

Now, if you have to have a mortgage, then by all means you should take the tax deduction for it. But please don’t get a bigger mortgage so that you get a bigger deduction. And don’t take out a home equity line of credit to pay for your vacation so that you get a deduction for the interest you pay on the cost of that vacation. No matter how big the deduction, you are still paying more for the vacation! You only get a percentage of the interest, not a dollar for dollar reduction of the price you paid.

One More Example

There is a guy I know that owns his own little business. Almost every time I talk to him he tells me about the new tools or equipment that he just bought. Then he smiles and says, “Hey, it’s a tax deduction.” Maybe he is just taunting me. But it is not like the fact that the tool is a tax deduction makes that tool free. Especially if he is not making a lot of profit on this business, which in turn means that his tax bracket is not very high. So, maybe he saved 20% on the tool when you take into account the write-off. He still spent the other 80% on a tool that he didn’t really need. It is the same logic that leads people to by things that are “on sale” that they never would have bought otherwise. I don’t care how much you saved – if you wouldn’t have bought it otherwise you just wasted your money.

* This article is commentary on basic principles. In no way should the things said in the article be construed or interpreted to be advice for your specific situation. Before making any financial decision you should consider all factors and consult with a professional.

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Remember, budgeting is not restrictive. You won’t be spending less, you’ll be spending right. You can do this! Today. Right now. What do you have to lose? Except all that debt and stress. (Ok, so kind of a lot.)

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