I recently wrote in detail about the first-time homebuyer savings account tax deduction offered by the state of Oregon, and promised a followup with an assessment of similar accounts offered by other states. If you haven’t read that post, then you should probably start there, since the concepts I describe there will be helpful as I skim through the remaining state offerings.
Virginia: 529 plans for housing
Virginia’s first-time homebuyer deduction is in most ways more generous than Oregon’s, with a few important catches to be aware of.
First, and most importantly, Virginia allows you to designate (almost) any account as a first-time homebuyer account simply by filing a statement alongside your state income tax return, and allows you to designate as many as you please, as long as the accounts only include “cash and marketable securities.” This is an incredibly expansive definition — in principle you could designate a Robinhood account and make all of your earnings exempt from Virginia state income taxes.
Second, there are no time or income limits. Oregon requires funds to be used for eligible purposes within 10 years of account opening or all your previous deductions are immediately reversed, while Virginia has no such requirement, and the Oregon tax deduction is phased out at high incomes, while Virginia’s is uncapped.
Finally, Virginia allows you to designate someone else as the beneficiary of your account, which is why I think of these as 529 college savings plans for houses. The account owner (whether or not they are an eligible first-time home buyer) is able to claim the state income tax deduction as long as the designated beneficiary is eligible.
There are two important drawbacks to Virginia accounts, although I don’t think they outweigh the advantages.
First, only interest, dividends, and capital gains are deductible, unlike in Oregon where contributions up to a certain limit are also deductible. This is, again, a feature they have in common with 529 college savings plans.
Second, you cannot claim any deduction for earnings that occur “while the principal in the account was in excess of $50,000” or “while the aggregate principal and interest in the account was in excess of $150,000.” But this limit is calculated separately for each account, you can designate as many accounts as you wish, and you can move cash and marketable securities freely between them. As long as you make sure to keep your balances in each account below $150,000, there’s no limit to the state income tax deduction you can claim.
This is, unfortunately for the people of Virginia, spelled out crystal clear in the Code of Virginia: “there shall be an aggregate limit of $50,000 per account” is about as clear as a tax code can get.
How to maximize
Since there are no time limits or aggregate contribution limits, but strict per-account limits, their value is maximized when you have the highest earnings-to-principal ratio in each account. In other words, if you make a $50,000 deposit to an account, then you only have $100,000 of earnings “runway” before the account needs to be chopped up into smaller accounts, while if you make a $5,000 deposit, you have $145,000 in earnings before the $150,000 cap is breached.
Finally, note that the account beneficiary does need to be a Virginia resident buying a home in Virginia in order to make tax-and-penalty-free withdrawals from the accounts (and the account owner needs to have Virginia income to pay Virginia income taxes, obviously), which makes these accounts ideal for stashing money away as long as possible to pay for a child’s house years or decades in the future.
The maximum state income tax rate in Virginia is 5.75%.
Colorado: strict contribution limits make for boring accounts
Colorado’s legislators put a little more thought into their tax deduction, so the possibilities for really hammering the accounts are much more limited. Contributions are not deductible, there’s an annual contribution limit of $14,000 (presumably for federal estate tax avoidance purposes), a total contribution limit of $50,000, and earnings are no longer deductible once an account has a value of $150,000 or more. There are no time limits on the accounts, so as in the case of Virginia, you’d ideally like to maximize the earnings-to-contribution ratio: a $1 contribution that generates $149,999 in earnings is 50% more valuable than a $50,000 contribution that earns $100,000.
The one relief Colorado gives is that you do not, in fact, have to be a first-time homebuyer in order to claim the deduction. Instead, you simply need to not be claiming a mortgage interest deduction. That might mean you don’t own a home, but it also might mean you own your home outright, or that the mortgage interest you pay isn’t enough to put your total itemized deductions over the threshold of the standard deduction.
The state income tax rate in Colorado is 4.63%.
Minnesota: restrictive, but lucrative
Minnesota has a range of additional requirements which limit the utility of these accounts. They have the same 10-year time limit as Oregon, with the additional restriction that the account’s designated beneficiary must be “a Minnesota resident who has not had ownership interest in a principal residence in the last three years.” Since you can change account beneficiaries at any time, this is a meaningless requirement, but it’s still important to keep details like that in mind, especially when filing your deduction for the first time. Earnings are deductible, contributions are not.
You can designate multiple accounts but Minnesota’s Department of Revenue offers astonishingly little additional information, so it’s unclear to me whether the $14,000 contribution limit is on a per-account basis or shared across all accounts; if you’re a Minnesota taxpayer, consult a tax professional before hammering these too hard.
The top state income tax rate in Minnesota is an astonishing 9.85%, which makes these the most valuable accounts I’ve reviewed so far, although they also have the toughest penalty on early withdrawals, a full 10% of the amount previously deducted (twice as high as Oregon’s 5% penalty).
Iowa: deductible contributions, limited options
Iowa has the same pesky 10-year time limit, but deductible contributions and a relatively high maximum state income tax rate nevertheless put these accounts in the middle of the pack. They appear to have an inflation-adjusted deduction limit (in 2020 it was $2,137 for single filers and $4,274 for joint filers). Frustratingly, they have a geographic restriction similar to Oregon’s, which is not on the account holder, but on the bank’s location: “A first-time homebuyer savings account must be an interest-bearing savings account opened at a state or federally chartered bank, savings and loan association, credit union, or trust company located in Iowa.”
I was unable to find any examples of accounts meeting that description with interest rates worth pursuing on their own, but Iowa’s top marginal income tax rate of 8.53% means the income tax deduction alone has a maximum value of $3646 over 10 years (on $43,740 in contributions). Oddly, earnings themselves seem to remain taxable, but since these accounts earn negligible interest that’s probably irrelevant to most Iowans.
Idaho: deductible contributions and interest(?), high annual limits
Idaho has a relatively modest maximum state income tax rate of just 6.5%, but their annual first-time homebuyer tax deduction is an incredible $15,000 for single filers and $30,000 for joint filers, with a total of $100,000 in contributions eligible for deduction for all taxpayers. The instructions for forms 40 and 39R are fairly inscrutable, as they refer in the “subtractions” section to interest being “tax deferred” while in the “additions” section there’s no reference to adding back in “deferred” interest, so my hunch is that both contributions and interest are deductible up to the $100,000 lifetime limit.
Despite the poor drafting of Idaho’s laws and regulations, the potential to hammer out $6,500 in tax savings in just three-and-change years seems like a no-brainer for those eligible.