Bigger home, bigger tax break - great deal?

NEW YORK (Money) -- Question: My wife and I are in the 33 percent tax bracket. We're getting the standard tax breaks for owning our home, having a child and making charitable contributions, but we're getting hit hard with taxes. Do you think we should buy a bigger home to get a bigger tax break? - J. Court, Houston, Texas

Answer: Many years ago, when I was self-employed as a freelance writer and trying to decide whether to upgrade to a more expensive computer, a friend of mine blithely offered this advice: "Of course, you should get a new one. After all, you're just going to write it off, right?"

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It was true that I could deduct the cost of the computer as a business expense. But that hardly means that it's free.

I still had to part with real money to get that computer. My money.

Although the analogy isn't perfect, I think the same rationale applies to your situation. Yes, buying a larger and more expensive home can lead to bigger tax breaks. A larger mortgage can translate into a larger mortgage interest deduction. If you pay points for your mortgage - and pay them in cash - you can deduct them. And, who knows, maybe you'll be really lucky and your property taxes will go up and you'll get a bigger deduction there as well.

But, remember, the deduction doesn't eliminate these costs. It just lowers them. So by buying a larger and more costly house you are increasing the amount of money you spend on housing, even after the deductions.

Granted, you are buying an asset that should appreciate in value over the long term, so you will likely be getting a return on the additional money you're putting into the house. But if you're going to justify buying more house not on the need for more space or better living quarters but on tax deductions and returns, then you need to consider whether you might do better putting any extra money you have in stocks.

Of course, assessing whether real estate or stocks is a better investment can get fairly complicated. But on a pure return-on-asset basis, stocks have beaten houses pretty handily over the long term, with house prices climbing about 6 percent annually since 1975 versus about 12.5 percent for stocks.

Yes, houses have other benefits, namely, the tax deductions, the exemption of up to $500,000 in gains for married couples, and the fact that you can live in a house. But when you factor in all the costs, houses have a hard time beating stocks.

(For a detailed look at how a house stacks up against equities, read the Real Estate vs. Stocks story that appears in the real estate cover package in the May issue of Money Magazine. While you're there, check out the forecast for house prices in the 100 largest metro areas as well as the features on what buyers and sellers should do to get the best deal in a housing market where buyers have the upper hand.)

I want to be clear that I'm not suggesting that buying a house is a lousy investment or that people should rent instead of buy (although renting often does make more financial sense than buying if you're planning to stay in the house only a short time.) Indeed, I'm a big fan of homeownership and own a big 'ole 80-year-old Tudor myself.

But I think it's important we think realistically about the investment potential of a home. Over the years, we've come to think of housing as a can't-miss investment, the American Dream as the Dream Investment. But even the National Association of Realtors is forecasting a slight decline in house prices for this year.

And after the last run-up in house prices in the late '80s and early '90s, house prices in some hot markets like New York and Los Angeles dipped as much as 20 percent and took almost as long as 10 years to regain their peak. (To peruse historical house prices by metro area, check out the Office of Federal Housing Enterprise Oversight's House Price Index. And for a unique view of how inflation-adjusted real estate prices have "rollercoastered" up and down from 1890 to present, check out this video.)

All in all, I believe the primary reason people should own a home is because they enjoy living in it. And while I think owning a home can be a good investment as well - assuming you don't buy at a market peak and move out within a few years of doing so - I don't think it makes sense to buy more home than you need because of the tax breaks or investment potential.

Besides, if you own a home, chances are, you've already got more than enough of your net worth riding on one asset. Better to spread around any extra money you have than to bet even more of your financial future riding on one house on one block in one neighborhood.

If your situation changes and you decide you want to spend more on a larger home because you need more space for a growing family or you decide you want to live in a better neighborhood with better schools, fine. Go for it. But don't do it for the write off.