PROPOSED MORTGAGE INTEREST DEDUCTION REFORM

October 17, 2011 – 12:46 pm

There has been much talk in recent months about the need to reform the tax code, especially as there are serious problems surrounding our nation’s debt. One proposed idea deals with reforming the mortgage interest deduction. In 2010, this deduction cost the Treasury Department an estimated $80 to $103 billion, and is expected to increase to upwards of $1 trillion over the next decade.

If itemizing, taxpayers owning primary and secondary homes can claim an interest deduction on mortgage interest paid related to these homes. Homes can include houses, condominiums, mobile homes, house trailers, and boats. Currently there are some caps on the eligible mortgage debt ($1 million of a first mortgage and $100,000 of a second mortgage). Even with these caps, taxpayers can save a significant amount of tax and thereby reduce the after-tax cost of owning a home.

The mortgage interest deduction is viewed by some to benefit those in higher tax brackets more than those with lesser incomes. For example, taxpayers in the 35% tax bracket have an after-tax cost of $65 on every $100 of interest paid, while taxpayers in the 10% tax bracket have an after-tax cost of $90.

Additionally, critics find that many in lower tax brackets are not utilizing the deduction because they receive a greater benefit from claiming the standard deduction instead. For example, a couple in a lower tax bracket who purchases a home for $150,000 may only pay approximately $9, 500 in interest in the first year. If this couple has no other deductions, it is more beneficial for them to claim the standard deduction of $11,400 rather than itemize and claim the lesser amount.

Advocates of the mortgage interest deduction claim that the deduction encourages, and makes more affordable, home ownership due to the after-tax cost-savings the deduction provides. However, others view this as incorrect logic and instead say that the deduction only encourages those in higher tax brackets to buy larger homes.

Several ideas for reforming the deduction have been brought to the table, including changing the deduction to a credit, which is seen as more progressive; modifying the maximum mortgage amount; and eliminating the deduction for a secondary residence. The proposed credit percentage ranges from 12% to 20% and varies from a refundable to a nonrefundable credit. Another proposal is to have a fixed credit for owning a home rather than having a mortgage, which may still encourage home ownership over renting. Some even feel the mortgage interest deduction should be eliminated altogether.

It will be interesting to see what changes take place over the coming months regarding the mortgage interest deduction. There appears to be enough buzz about this topic that some sort of reform may be likely. In any case, rest assured that RedGear will implement the necessary adjustments to conform to any changes in the tax law.

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