Home Mortgage Interest Deduction Could be Reduced

June 15, 2011

in Homeowner Taxes

Summary of the National Commission of Fiscal Responsibility and Reform

Many Americans just finished filing their taxes for 2010, and roughly a third of taxpayers itemized deductions on their tax returns. For many taxpayers, the decision to itemize or not is driven primarily by the amount of their home mortgage interest deduction. The average homeowner deducts over $10,000 in home mortgage interest, which for a taxpayer in the 25 percent tax bracket, results in a tax savings of approximately $2,500.

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All of that could change; however, as the bipartisan National Commission of Fiscal Responsibility and Reform slices and dices tax breaks in an effort to reduce our nation’s $14.3 trillion debt. Economists, lawmakers, tax analysts and Obama administration officials question whether the United States can afford to give generous tax breaks when the country is carrying such massive debt. One of the national debt reduction commission’s recommendations involves reducing the tax deduction on home mortgage interest. This would not only affect homeowners’ taxes. It could also have detrimental effects on an already fragile housing market.

Our earlier article on Home Mortgage Interest Deductions explained the history of the home mortgage interest deduction, how the removal of the home mortgage interest deduction could affect the housing market, and earlier proposals by the National Commission of Fiscal Responsibility and Reform. Let’s take a more detailed look at the recent summary of the National Commission of Fiscal Responsibility and Reform’s report as it relates to the home mortgage interest deduction.

The national debt reduction commission’s report recommends reducing or eliminating several tax breaks claimed by millions of middle-income Americans, and President Obama has proposed limiting itemized deductions for the wealthiest 2 percent of taxpayers. The reduction of the home mortgage interest deduction is just one of these itemized deductions, but it is a big one. As quoted in our earlier article, according to the Tax Policy Center:

“In 2012, the MID [mortgage interest deduction] will cost the federal Treasury an estimated $131 billion, much more than the total of all outlays by the Department of Housing and Urban Development ($48 billion). Homeowners also benefit from other federal tax preferences, including deductibility of residential property taxes on owner-occupied homes ($31 billion), and exclusion of tax on the first $250,000 ($500,000 for joint returns) of capital gains on housing ($50 billion).”

Unfortunately, the home mortgage interest deduction is not a target simply because of its cost to the U.S. Treasury. Many feel that tax breaks on home mortgage interest contributed to the collapse of the housing market. Critics argue that home mortgage interest deductions acted as an incentive for people to go deeper into debt, funneling capital into the housing market, and causing the real estate bubble that eventually popped.

The summary of the National Commission of Fiscal Responsibility and Reform proposed replacing the home mortgage interest deduction with a 12 percent tax credit and reducing the one million dollar limit on home mortgage interest deduction to $500,000. A tax credit helps reduce the amount of tax a taxpayer owes the government, and a tax deduction helps lower the taxpayer’s taxable income. The National Commission of Fiscal Responsibility and Reform’s proposal would also eliminate tax breaks on second homes and home equity loans.

In addition to the work being done by the National Commission of Fiscal Responsibility and Reform, a bipartisan task force led by former Republican chairman of the Senate Budget Committee, Pete Domenici, and the former Clinton administration director of the Office of Management and Budget, Alice Rivlin, is proposing replacing the home mortgage interest deduction with a 15 percent tax credit, and President Obama’s 2012 budget would limit the deduction for families in the top tax brackets.

How Would Changes to the Home Mortgage Interest Deduction Affect the Real Estate Industry?

Changes in the home mortgage interest deduction will not happen easily. This is not a tax deduction that only affects the rich; the home mortgage interest deduction is enjoyed by millions of Americans. Plus, limiting the home mortgage interest deduction could result in a further decline in home prices. The National Association of Realtors® President Ronald Phipps said that the proposals to limit the home mortgage interest deduction have upset potential homebuyers at a time when the housing market is still recovering:

“Since income taxes were first introduced into the tax code in 1913, the deductions for home mortgage interest were included,” Phipps says. “My grandparents, my parents and I have taken advantage of that deduction. We think it’s a matter of fairness for future generations that they have it.”

The NAR has asked its one million members to contact their congressional representatives and urge them to preserve the tax break. Homeowners interested in preserving the home mortgage interest deduction could do the same.

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