Mortgage Interest Tax Deduction

By:
Daniel Lahage, CPA
Published Date:
Jun 1, 2016

During every election cycle, a set of tax proposals set forth by candidates become topics for debate. Whether or not each candidate will actually be able to implement that tax policy is another question. One hot button issue that has crept back into election year tax policy discourse has been the Mortgage Interest Tax Deduction (MITD), detailed in IRC section 163(h)(3)(A), which allows taxpayers to take a deduction of a qualified residence mortgage interest. It has been discussed on both sides of the aisle in Congress and mentioned by multiple presidential candidates.

Qualified residence interest is interest paid or accrued during the taxable year on acquisition indebtedness or home equity indebtedness secured by any qualified residence of the taxpayer. A qualified residence is defined as a taxpayer's principal residence plus a second home. IRC section 163(h) (3)(C), which defines home equity indebtedness, has been clarified by the IRS in Revenue Ruling 2010-25, which stated that a taxpayer can deduct interest on up to $1.1 million of debt securing the purchase of a taxpayer’s qualified residence.

Some candidates have called for abolishing the MITD. The bipartisan National Commission on Fiscal Responsibility and Reform, however, has recommended the less drastic action of converting the mortgage deduction into a 12% tax credit, capped at $500k of acquisition debt. The proposed nonrefundable tax credit, only available to those with federal tax liability, would assist taxpayers who do not itemize while greatly reducing the tax break for those with large mortgages.

The real estate industry and mortgage bankers have been outspoken proponents of keeping the MITD, arguing that its removal would destroy the residential housing market.

Candidates and elected officials have made many arguments for eliminating the MITD. As of 2016, the MITD is estimated to reduce federal revenues to the tune of $75 billion per year, making it one of the largest annual federal tax expenditures. That number does not include the amount lost by state coffers that recognize the break. Critics of the MITD argue that the tax break does not benefit renters or standard deduction filers – and is one that the federal government is subsidizing for a single economic activity through the tax code and targets a generally wealthier population.

Proponents of eliminating the MITD also point out that elimination can help elected officials indirectly raise revenues while shielding them from accusations of tax hikes by their constituency. It could also fiscally prepare policymakers to pass simplified lower tax rates in general. Other industrialized nations, such as Canada, do not offer a MITD – but have slightly higher home ownership rates than the United States.

Removing the MITD, however, would destroy a major incentive for home ownership. Less prospective buyers would consider jumping into monthly payments consisting of principal, interest, insurance, maintenance, HOA dues, repairs, and property taxes that offer them little or no break from their taxable earnings. The flexibility of moving and not having to unexpectedly break the bank for a new roof or HVAC unit could tilt the balance in favor of renting.

There would also be an overwhelming backlash from the general public against removing one of the greatest tax benefits utilized by middle-class homeowners. The MITD is one of the few breaks left that minimally correlate with AMT disallowance calculations. Because this tax benefit is already factored into the price of homes throughout the nation, removing it would eviscerate trillions of dollars of established home equity from the housing market. Many existing homeowners went into their purchase determining how large of a 30-year commitment they could afford, with the assumption they would receive this tax break for the duration of the loan.

To argue it is a deduction simply used to benefit the super wealthy is disingenuous. The American Taxpayer Relief Act of 2012 reinstates the Pease provision, which placed limits on itemized deductions on incomes above a certain threshold and restrains any benefits the wealthiest of taxpayers would attempt to seek from this deduction.

In some parts of major urban centers within our nation - for example, New York City and San Francisco - the maximum $1.1 million of acquisition debt available to a taxpayer through the provision could barely cover the cost of a simple one-bedroom condo. These supposed “investments” buyers are taking advantage of through this tax break are properties subject to local taxation, surcharges, levies, and assessments, that in turn subsidize and fund municipalities in facilitating their essential operations. New York City has a mortgage tax due at closing that can go up to 2.175% of the principal. It also has an additional 1% “mansion tax” on properties over $1 million. Residential property taxes within many counties of the Tri-state area are among the highest in the nation.

Lastly, the $75 billion in lost federal revenue has a very plausible counterargument. The revenue is not completely lost because the banks report the interest received as revenue on their income statements. It is simply shuffling monies from individuals to be taxed at (in many cases higher rates) the lenders’ entity level.

This is one of the few provisions of the tax code that rewards workers who are gradually striving to achieve the American dream of a retirement free of future mortgage payments and rent. The MITD is, in essence, a middle- to upper-middle-class tax break that is worth maintaining, and the merits of the deduction far outweigh its deficiencies.


LahageDanielDaniel Lahage, CPA, EA, MST, is a long time financial and MIS analyst in both the private and public sectors. He is an active member of the Staten Island Chapter of the NYSSCPA and sits on the Society's Taxation of Individuals Committee, chairing evening CPE Technical Sessions. His accounting and tax practice, located in Brooklyn, NY, serves high-net-worth individuals, families, entrepreneurs, and start-ups. He is involved in local community civic organizations throughout New York City. He can be contacted through www.LahageCPA.com

 
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