Mortgage Interest Rate Deduction: Do We Really Need It?

My stance in last week’s article about the home mortgage interest deduction being inherently unfair to some taxpayers stirred up a considerable amount of controversy.

I argued that childless renters making a good income tend to be on the losing end when it comes to the tax breaks. Most readers pointed out that renters do not have the overhead that comes with owning a house, which means the write-off of mortgage interest and property taxes levels the playing field.

Aside from those two deductions, other expenses such as homeowner’s insurance, repairs and maintenance and replacement of capital items such as hot water heaters, roof, heating and air conditioning systems are not deductible expenses. Down payment or closing costs can’t be written off, but loan origination fees (points) are deductible. Renters are not responsible for any of these costs.

On the surface, it appears to be a valid point. However, one must consider the homeowner’s ability to increase equity when property values rise. There will always be peaks and valleys in real estate prices but for most people, most of their wealth is in their home and it provides a nice nest egg. Even if the house is never sold and a profit recouped from any outlays, it can be left to heirs. A renter does not enjoy that luxury.

Another tax benefit of home ownership comes when the house is sold. Selling a home can bring a tax-free exclusion from profit of $250,000 for single individuals or $500,000 for married filing joint.

The owner of a rental property enjoys the deduction of mortgage interest, property taxes, and all other ordinary and necessary expenses incurred in the business of being a landlord including insurance, repairs, security, utilities, HOA fees, management fees, landscaping, etc.  These landlords can also claim depreciation expense, which is a write off of the purchase price of the dwelling over 27.5 years if residential and 39 years if commercial. The investment into a rental property affords more chances for current year deductions than an investment into other vehicles such as stocks and bonds. After all, you are not allowed annual depreciation for the cost of a stock.

A landlord may sell a rental property for a lucrative profit and via what the tax code calls a 1031 exchange, may defer taxes on the sale of the property when trading up to another rental unit(s). You can’t do that with stock either.

When it comes to taxes, property ownership has always been extremely attractive. But not everyone can put the money together to make the investment and enjoy the benefits.

A renter basically throws money into a temporary situation with no enjoyment of a tax deduction or credit or security for longevity of tenancy. And it’s not just renters who lose out. There are some folks who paid cash for their homes and others who took out 15-year mortgages that are now paid off. There are seniors who have paid off their homes that are now paying taxes on their Social Security income. All of these groups no longer enjoy the mortgage interest write off, but must contend with the costs of home ownership: property taxes, insurance, maintenance and repairs, HOA fees to name a few. In fact, their property taxes are likely no longer deductible because they no longer qualify to itemize deductions.

Jason Fichtner, a senior research fellow at the Mercatus Center at George Mason University, and David Camp, (R-MI), want to change the tax code to provide fairness to those who can’t afford to buy a home.

Dennis Ponton, a certified public accountant in Oakton, Va., says “The social policy of promoting home ownership is admirable, the mortgage interest deduction should apply elements of fairness in the tax system and withhold rewards for speculative and financially irresponsible behavior. In both regards, the deduction fails.”

Many opponents claim that the mortgage interest deduction does not encourage home ownership—just debt.

Ponton goes on to explain this premise by discussing the ability of homeowners to open equity lines secured by their homes. Some people use their home as a “virtual ATM” to finance vacations, buy cars, pay off credit cards or other consumer debt, and can enjoy the write off of up to $100,000 of equity line interest. Yet, this debt has nothing to do with the purchase of the home.

With the tax reform act in 1986 such consumer interest became no longer deductible. So while those without equity lines are unable to deduct interest on cars and credit cards, those with homes and equity lines may do so.

Finally, Fichtner says, “… one synonym for fair is even; and for fairness would be even-handedness. The mortgage interest deduction fails that test. The mortgage interest deduction also fails at its original public policy purpose: to increase home ownership.” He adds that his paper Reforming the Mortgage Interest Deduction shows that the U.S. has lower rates than countries without similar subsidies. “It also does nothing for those at the lower-end of the spectrum help purchase homes.”