They are the most treasured of all the sacred cows in taxation. Threaten them and you will be reviled. Mention that they are becoming irrelevant and your sanity will be questioned.
Yes, I’m talking about home mortgage interest and real estate taxes as beloved itemized deductions. I’m also saying that it is time for them to go.
I’m serious. Please bear with me for a few minutes before throwing the rotten tomatoes.
The notion of eliminating the deductions for home mortgage interest and real estate taxes, two of the largest tax breaks we consumers have, came to mind after I examined the stunning data for housing affordability in a recent column. I realized that losing the deductions would affect only a few areas of the country and a small segment of the population.
Here’s the basic case:
The Federal Reserve has given homeowners a bigger break than the IRS ever will.
How can this be? Simple. Back at the peak of the housing bubble, home mortgage rates averaged 6.82 percent. Today rates are running about 3.57 percent, a decline of 48 percent. Since most of us get a tax benefit of 15, 25 or 28 percent on our interest deductions, riding the home mortgage refi gravy train over the last six years has been a lot more valuable than any tax break.
If you’ve ridden that big payment reduction train I have a suggestion. Rather than sending a thank you note to Federal Reserve Chairman Ben Bernanke, take a senior citizen to lunch and express your gratitude. Your lower interest payment has come out of the yield on her savings. In this kind of thing there is no free lunch. And you’re the one who now has the money to pay for lunch.
Another implication is that if we really want to simplify our tax code— reducing deductions as a way to get the lower tax rates the Simpson-Bowles commission suggested— this is the time to do it.
The standard deduction is so high most homeowners don’t benefit from itemizing.
One of the things the fans of itemizing mortgage interest and real estate taxes seldom recognize is that you only benefit when your deductions exceed the $12,200 standard deduction on a joint return and $6,100 on a single return. So while everyone has kind thoughts about the beauty of home-related tax deductions, the reality is that lots of people don’t have much in other deductions, either. Medical deductions are limited. Charitable contributions are smaller than we’d like to think. Basically, shelter deductions are the ball game unless you live in a state with a punishing income tax.
So let’s do the math. At current mortgage rates and with a real estate tax equal to one percent of market value, you’d need to own a house worth more than $316,000 before you would begin to enjoy a reduction in your income tax. (This assumes a 20 percent down payment.) Raise the real estate tax rate to two percent of market value and you get there at a lower home value, $251,000. Since most homes are taxed at one to two percent of market value, there is no tax benefit for homes of lower value.
Now examine median existing home sale prices across the country, as compiled by the National Association of Realtors. Of the 154 reporting metropolitan areas in a recent report, 14 had median home sale values over $316,000. Only 19 had home median sale values over $251,000. Add sly little facts like the reality that many people didn’t buy their homes yesterday and have more than 20 percent equity. Or that an impressive 30 percent have no mortgage, and the benefit of itemized home deductions really isn’t all it’s cracked up to be.
The deductions are only important in what might be called “the usual suspect cities”— places like San Jose/Sunnyvale/Santa Clara; Honolulu; San Francisco/Oakland/Fremont; Anaheim/Santa Ana/Irvine; and New York/Wayne/White Plains. These places had median sale prices from $467,800 to $673,000. In those areas the tax breaks to offset the cost of shelter compensate a bit for the most punishing state income taxes in the country.
The mortgage and real estate tax deductions have become perverse incentives.
While tax breaks in high cost areas allow some upper middle income households to own houses, the tax breaks have nothing to do with what Congress originally intended, which was to increase the rate of home ownership for the middle class.