Mortgage deduction on the hot seat
Homeowners love the mortgage deduction. So do real-estate agents and homebuilders. But it costs the government billions in lost tax revenue and may be trimmed back to fix the fiscal-cliff problem.
But it is being talked about in the context of fixing the fiscal-cliff problem, and it is one that all homeowners with a mortgage probably should be watching. But a legitimate question is whether the mortgage deduction is morphing into a tax break only for the affluent. There will be a big, loud fight over the mortgage deduction because it has been one of the most cherished of all tax breaks.
Here's what makes it so popular:
If you buy a house with a $150,000 loan at 3.5% annual interest (the current rate on a 30-year fixed mortgage), you will pay $5,204 in interest. If you're in a 25% bracket and you itemize, your income tax bill drops by $1,301.
This assumes you can itemize deductions on your tax return. In 2012, for married couples filing jointly (which is most of us), your total deductions must exceed $11,900, so make the effort to list out charitable contributions, property taxes, state income taxes and the like. The IRS hasn't yet announced the standard deduction for 2013.
Here's why asking if the mortgage deduction is turning into a tax break simply for the affluent. Mortgage rates are down 43% from the 6% level that prevailed in 2007. That means the interest paid on a new mortgage is now much less.
So, let's say you're buying a house and want the mortgage interest to top the $11,900 threshold. That means you need a mortgage of around $350,000. That might not buy you much in New York, Los Angeles, the San Francisco Bay Area or Washington, D.C.
Nationally, however, the median price of an existing home in October was $178,600, according to the National Association of Realtors. The median price of a new home in October was $237,000, the Commerce Department reported on Wednesday.
In 2007, when mortgage rates were around 6%, the interest you would have paid on that $150,000 loan would have been $8,950. In 1982, when mortgage rates hit 15%, your interest in the first year would have been $22,500.
Fact is, as of 2010, only 25.8% actually claimed the mortgage deduction, deducting some $387 billion in the process, according to the Internal Revenue Service's Statistics of Income. That percentage is down from 28.8% in 2006, just before the housing bubble started to burst. And the number of taxpayers claiming the mortgage deduction fell by 10% in 2010 from a peak in 2007.
OK, the percentage who claimed the deduction in 2011 may be up a little, and it may rise again in 2012 as evidence mounts of a housing recovery. But lower interest rates are clearly limiting the value of the deduction in much of the country, especially for new homeowners.
If that's the case, why is the mortgage deduction defended so fiercely? The short answer is you have always been able to deduct the interest on your house under the IRS code. And, especially since World War II, one of the key selling points of homeownership has been the deduction.
Another has been the potential for capital appreciation. A third -- though less talked about -- is the fact that paying down a mortgage is a form of saving.
The deduction is in fact capped. You can only deduct up to $1 million in mortgage interest on one or more homes and up to $100,000 on the interest on a second mortgage.
The mortgage deduction has been used to promote homeownership, believed to be an important American value because it promotes economic and social stability.
It also gets a defense from Kevin Villani, former chief economist at Freddie Mac. Homeownership and the buildup of equity in the home have been important sources of seed financing for small business.
The case against the mortgage deduction is that it historically has favored one group of taxpayers -- homeowners -- over renters. The United States is the only industrialized nation that gives homeownership such tax treatment.
And critics, mostly from the right, say the mortgage deduction draws capital away from new factories and equipment and into the construction of big suburban houses.
An important question is whether junking the deduction would make much difference to homeownership rates.
Hard to say. BusinessWeek says it was 62.5% in the second quarter, after foreclosures and delinquencies are taken out. That's down from a peak of 68.3% in 2004 and 2005.
The decline has everything to do with the housing bust and falling prices.
The odds are that the deduction will survive in a world where itemized deductions are capped. Former Massachusetts Gov. Mitt Romney proposed a $25,000 cap on all itemized deductions during the recent presidential campaign. The Obama administration is warm to the concept if not the amount.
Republicans want to discuss the idea as part of a broad tax-reform package. But no one has actually put much on paper. And that's scary to Kenneth Rosen, who teaches real-estate economics at the University of California, Berkeley.
The problem isn't reform. The problem is that the tax code is so huge and complex that quick changes cause more problems than they solve, he says.
Case in point: The 1982 tax reform package promoted by the Reagan administration. The law created so many tax breaks for commercial real estate that money poured into the sector. Within two years, the law had to be amended to cool the business off.
Tax policy should be used for one reason - to obtain revenue to fund the gov. But that's not what we have anymore. 90% of current tax policy isn't about generating revenue - it is simply just a way to control behavior or to gain political advantage. If the actual goal was really just revenue, our tax code could be less than 50 pages.
How about going back about four years when President Obama suggested taxing the Mcmansions? He must have forgot when he said he would tax homes on square footage over 2,400 square feet. That would bring in some money.
I would like to suggest another one that would bring in more money. How about making the standard deduction for kids limited to two? Why should the taxpayers pay for those that want to have more than two kids? Think "19 Kids and Counting" and let them pay for the rest of the gang.
Removing the home mortgage interest deduction will cause major headaches to the IRS. Purchasing a home is no different than buying stock on margin, buying a business on credit, or buying a rental property with a mortgage. The IRS has already declared ALL real estate to be an investment. Do you pay capital gains if you sell it at a profit? Do you get a deduction for it if you sell it at a loss? Yes you do. Thus, it is an investment and you are entitled to a deduction of the costs of financing the investment just as if you bought stocks or bonds on credit.
If they get rid of the homeowners deduction, I will transfer the property to a new LLC and rent the property from the LLC. I will then get to depreciate the building too!
The article says the mortgage tax deduction is becoming a deduction that only benefits the affluent. So is that the case for throwing it out?! How about lowering the standard deduction so that more people (with smaller mortgages) can itemize! The arguement from the right for throwing out the mortgage interest deduction also includes implementing the fair tax. How about reporting the whole story instead of always trying to throw an ideology under the bus...
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A basic income policy can actually ensure a decent standard of living for everyone.
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