In February of this year, President Obama established the National Commission on Fiscal Responsibility and Reform (www.fiscalcommission.gov). Their mission was to identify “policies to improve the fiscal situation in the medium term and to achieve fiscal sustainability over the long run.” Their first task was to issue a report on recommendations to achieve their overall mission by December 1, 2010. As required, on December 1, the commission issued their report and, perhaps humorously, titled it “The Moment of Truth.” The report goes over a wide range of plans in discretionary spending cuts, tax reforms, health policies, social security, process reform and mandatory policies. In the tax reform plan, the commission made a suggested change in a rule that has the real estate industry, and various trade organizations up in arms.
Mortgage Interest Deduction Policy – Now and the Suggested Future
There are many benefits to home ownership. One of these benefits is the mortgage interest tax deduction. What this basically does is allows the homeowner to deduct that they’ve pad in mortgage interest from their taxes. Definitely a great benefit for homeowners.
The current mortgage interest deduction (MID) rules allows you to deduct all the interest you pay on your mortgage(s) as long as you itemize your deductions on your tax return and if the mortgages are for your primary and/or secondary residence(s) totaling $1 million or less. Your interest on home equity loans of $100,000 or less would also be deductible as well. For full specifics contact your tax adviser or look through the IRS page on mortgage interest deductions.
The Deficit Commission proposed the following changes:
- Change MID from entire amount of interest to a 12% non-refundable tax credit
- Lowering the mortgage amount cap from $1 million to $500,000
- Eliminating credit for interest from second residences and home equity loans
Since these suggestions from the commission are not actual policy, details on how they would be implemented are not available. One open question I have what the 12% would be applied to. One accountant I spoke with felt it could be a flat 12% off of the taxpayer’s income. It also could be a 12% on the total mortgage interest you paid. Regardless, this policy would mean a huge hit on what homeowners could get back in a tax refund. I plugged the new limits into my 2009 taxes to see what would happen and assuming it’s 12% of the mortgage interest (rather than total income), my tax liability went up about $4000-$5000. Obviously not cool, but definitely not as tragic
If you’re wondering what a non-refundable tax credit means, according to the accountant I spoke with, it means the deduction cannot take your owed taxes below zero, which in turn give you a refund in excess of the taxes you paid in. Meaning if after all your other deductions, your taxes owing is $0, taking an additional non-refundable tax credit would have no effect.
National Association of Realtors’ Flawed Case Against MID Changes
Ron Phipps, 2011 National Association of Realtors President issued a statement the same day the commission released its report. The statement expressed his disappointment that anyone would even suggest changing or limiting the MID claiming that by doing so it would threaten the “stability of the American housing market and economy.” As evidence, he cites a survey commissioned by NAR and conducted by Harris Interactive of nearly 3000 homeowners and renters that found,
…nearly 3/4ths of homeowners and 2/3rds of renters said the mortgage interest deduction was extremely important to them.
Okay. I’m not a survey expert, but to simply ask how important the mortgage interest deduction is to them is like asking how important is it to have money or have food. Of course it’s going to be important for pretty much anyone. Wouldn’t most people consider paying fewer taxes important to them? A better question would have been asking the homeowners if the reduction or elimination of the mortgage interest deduction would have an impact on their ability to keep their house. For the renters, a better question would have been how the interest deduction changes would affect their decision to buy a house in the future. As the NAR had it, the results of the survey provided absolutely no real value except to sound shocking. (Not being able to see the actual survey myself, I realize that it may have asked questions like I suggested, but those data points were not revealed anywhere publically so I have to assume they were not asked.)
With the NAR statement and the broadcast email calling on agents to take action, the NAR is understandably doing what they feel they must do… look and sound relevant. Unfortunately, their arguments are misleading, incomplete or simply mistaken. Take this quote from their statement as another example,
Recent progress has been made in bringing stability to the housing market and any changes to the MID now or in the future could critically erode home prices and the value of homes by as much as 15 percent, according to our research. This would negatively impact home ownership for millions of Americans, including those who own their homes outright and have no mortgage.
Word choice here is important. The NAR actually has no idea what would happen. It “could critically erode home prices” or it could be just a blip on the radar. It “could” bring values down by “as much as 15 percent” or it may not. I would love to see the research they referenced as I could not find it readily.
Let’s look at the issue with some common sense now. Every homeowner makes a mortgage payment, usually once a month. Whatever interest they are paying on their loan is paid through their monthly payment. Most Americans pay their federal taxes through their employers from every paycheck. It is not until the following year when the homeowner files their tax returns with the MID and may or may not get a tax refund a few weeks later. The negative impact to homeowners is that they may not get as large of a tax rebate the following Spring. If we lost the MID completely, would it have a direct effect on individual homeowners from making their monthly payments? I don’t see how it could. So if it doesn’t effect a homeowner’s ability to pay their monthly payments, how does it actually impact their ability to continue owning their home. What would have a negative impact on home ownership is the loss of income or reduced income. If you consider and depend on your tax rebate as a reliable source of income every year, … well, … you shouldn’t be and you should probably look at your spending habits carefully.
Then there’s the part that it would negatively impact home ownership for those “who own their homes outright and have no mortgage.” I’m scratching myhead on this one. If you have no mortgage, you inherently pay no mortgage interest. If you pay no mortgage interest, what mortgage interest deduction could you claim on your taxes? None! So if you don’t have any mortgage interest to deduct, then how would ANY change in the MID have ANY effect on people who own their homes free and clear? While it is true that if property values declined it would affect ANY homeowner, I don’t think NAR can reliably associate changes to the MID and a decline in property values …especially a 15% decline.
So what does affect home prices? I say it in my monthly statistics updates; prices are a function of supply and demand. How NAR determined that prices could fall 15% from a change in the MID is a mystery to me. I can’t see how the MID has any direct effect to supply or demand. With no direct effect, then any price erosion is from another cause and not directly from changes to the MID. However, according to Mr. Phipps’ email, he believes that the media attention being given to this issue will scare potential buyers away. The MID is a benefit of home ownership, a benefit that you will not realize until you get your tax refund the following Spring. If the loss or reduction of the MID has a real and negative effect on a person’s ability to buy a house, then I would suggest that this person isn’t yet ready for homeownership. Scott Burns over at Asset Builder wrote a pretty good piece in November that has another way of looking at how uneventful a reduction or loss in the MID would be.
The Effect of the MID Changes on Investors
How do these suggested changes apply to investment/rental properties? Based on my research on the IRS website and discussions with my accountant, I don’t believe the suggested changes have any effect on investment/rental properties. The changes apply to primary and second homes which are defined on IRS publication 936. Since a pure investment or rental property does not fit in this definition, the proposed changes to the MID should not apply. As with everything, there are limitations and restrictions, but generally any expense paid for an investment/rental property can be used to offset the income that the investment/rental property generates on a Schedule E form. This essentially lowers your taxable income which is arguably better than having a tax credit. Jonathan from MyMoneyBlog has it very well laid out in more detail if you’re interested to see. Bottom line, investment and rental property owners shouldn’t have to worry about these proposed MID changes.
Moving On
The deficit commissions suggestions are not law nor will they become law anytime soon. It actually may never become law. The point here is if it or some variation of what was suggested does become law, I don’t believe the effect will be anywhere near as bad as the NAR fears. Another thing to consider is if lawmakers pass any changes to the MID there’s a good chance the full change would be phased in over time. Another good idea would be to follow the structure of the mortgage industry’s conforming loan limits. The limits change based on the area of the house. This would help a lot of people who live in expensive areas like San Francisco to still be able to realize some tax benefit.
We won’t know the true effect of any changes to the MID until a real law is passed and integrated into our lives. Until then, be careful before you start drinking NAR’s kool-aid.
Sources/References
National Association of Realtors
The White House
National Commission on Fiscal Responsibility and Reform
IRS
Asset Builder
My Money Blog
The VerraTerra Way
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About James
If the mortgage deduction is eliminated, the motivation to own a home would fall, especially where home values are not appreciating. Special interest groups will oppose even the smallest change.