Happy New
Year! Sometime in the very near future, our Congress is going to start picking
apart our current tax structure. This examination of allowable deductions is
not part of the New Year’s Eve wrangling that is going on as I write this. But,
for at least a month, I have been getting frantic emails from Realtor®
organizations that the sacred “Mortgage Interest Deduction” is an endangered
species that must be protected. (Pardon the mixed metaphor. The hyperbole
around this subject has no subtlety.)
I asked my financial planner
about whether he took these dire warnings seriously. He said that the deduction
will not go away. “It is a political third rail.” No one is going to let that
deduction disappear. Then, I asked my tax accountant. He wrote, “Attempting to
remove the mortgage deduction would be politically difficult, (if not
suicidal). However, attempting to cap all deductions would be much easier
to sell unless the nation's charities could successfully combat the notion.” The
guys I depend on for information about taxes both think this deduction is both
necessary and untouchable.
When real estate came up at
a party, I mentioned the deduction and got a similar reaction. People see
questioning the mortgage interest deduction is equal to saying home ownership
is unnecessary to the economy. The deduction, they say, “is huge!” So, it seems
that tax-related professionals and the home-owning public see this deduction as
very important and a political hot potato.
I asked my
tax accountant to explain the deduction, he wrote:
On the most basic level, the mortgage deduction may reduce your taxable income on a dollar to dollar level. I say may because the amount of the mortgage deduction (plus state tax and other deductions) has to be quantified against the standard deduction. Reducing your taxable income reduces the amount of taxes you pay.Usually the mortgage deduction is the vehicle that allows middle class families to itemize their deductions (and thus begin to fulfill the American dream). The important consideration on this subject to remember is that "the higher your personal tax rate the more significant the mortgage deduction becomes".For many people, they could not afford their house or condo if their tax burden wasn't being reduced by the mortgage interest deduction. This is part of why you are getting pressure from Realtors®.
I think differently from
most of my real estate agent peers. My first thought about this deduction is
that the emphasis on it is way out of date. Houses are not the tax shelter that
they used to be. The reason: low interest rates.
Mortgage interest rates have
been as high as eighteen percent in my lifetime. But, that’s not so normal.
Normal is more like seven to nine percent. It’s just that we have been spoiled
in the past fifteen or so years, when mortgage interest rates have been hanging
well below six percent for most of this generation of house buyers.
Let’s do a little math:
Suppose you have a mortgage
for $300,000. Your interest payments are front-loaded, so you pay far more interest
and far less principal in the earlier years. The tax deduction is on the
interest, so you get bigger deductions in the beginning when you are paying
interest more and principal less.
If your interest rate is a
typical seven percent, your interest in the first year will be roughly $1750 a
month – that’s $21,000 in the first year. In year five, it is roughly $1640 a
month – that’s $19,680. In year ten, it goes to $1490 – that’s $17,880. At year
fifteen, it is down to $1275 -- $15,300 annual deduction. These figures are
significant tax shelters.
With current interest rates
around three percent for 30-year mortgages, the picture is very different. Interest
in the first year will be roughly $750 a month – that’s $9,000 in the first year.
In year five, it is roughly $660 a month – that’s $7,920. In year ten, it goes
to $560 – that’s $6,720. At year fifteen, it is down to $450 -- $5,400 annual
deduction. It’s a tax shelter, but not like it was when interest rates were
higher.
I am not jumping up and down
screaming that the mortgage interest deduction is vital to the housing economy.
I am being a rebel without a cause?
2 comments:
I love the notion that itemizing deductions is the american dream.
I agree, the mortgage interest deduction isn't critical to the market. Personally, I think we would be better off without it.
On the other hand, it is a widely popular tax break, even for people who would benefit from its elimination (those who take less advantage of it than the average taxpayer). So I agree it is political suicide.
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