Would You Miss the Mortgage Interest Deduction?

How much do you like your deduction for home mortgage interest? If it goes away, would you miss it?

It’s now clear that when the National Commission on Fiscal Responsibility and Reform delivers its report next month it will focus on the reduction or elimination of “tax expenditures.” These are deductions from taxable income that lawmakers provide to promote one thing or another. The deductions associated with home ownership— mortgage interest and real estate taxes— are in that category. They cost billions in forgone tax revenue.

I can already hear your teeth grinding.

You’re thinking, “Sure, what else can our government do to kick the housing market when it’s down? It’s bad enough to have nitwit lenders demonstrate that they are as incompetent at foreclosure as they were at lending. Now Washington wants to take away one of the great middle class tax breaks, too?”

I like the way you think. And it is very likely that our friends in Washington will soon demonstrate, yet again, that they are the Grand Masters of Rebranding. They will turn a hideous tax increase into a spiritually uplifting tax reform.

But when push comes to shove losing such deductions may not be so terrible. You can see why if you stay with me while we explore the tax code and the cost of housing around the country. Let’s start with the tax code.

When we file our tax returns we have a choice. We can itemize deductions and add up all we spent on mortgage interest, property taxes, state income taxes, charity, and some medical expenses. According to recent IRS data only one-third of all income tax filers itemize. The remaining two-thirds just take the standard deduction, $11,400 for a joint return, $8,350 for a head of household return, and $5,700 for a single return. For most people, the standard deduction is a pretty hefty number— and it is indexed for inflation, so it only gets bigger.

Beyond that, two-thirds of the returns that itemize deductions have adjusted gross incomes (income before deductions and exemptions) under $100,000. This means that most of those who itemize probably get a tax benefit of about 15 cents for each dollar of deduction in excess of their standard deduction.

That’s not a big tax saving. So it’s pretty reasonable to say that itemizing deductions only provides a significant benefit for the one-ninth of all taxpayers who itemize and have incomes over $100,000 a year. And some in that group don’t own homes.

Now let’s go to the second part of the puzzle— the geographic distribution of home prices. If you visit the website for the National Association of Realtors you’ll find their regularly updated figures for the recent median home price in each of 154 cities. The report for mid-2010 shows the median price in the entire country as $176,900.

What do you think the deductions for that house are? If you figure a 20 percent down payment, a 4.75 percent interest rate, and a typical one percent of home value real estate tax you’ll come up with deductions of $8,453. To get deductions equal to the $11,400 standard deduction on a joint return, you’d have to spend $237,500 for your house.

 In Texas, a state with no income tax but a real estate tax approaching 2 percent, you would need a house worth more than $196,500 to have itemized deductions that exceed the standard deduction for a couple filing a joint return. The median home price in the Austin area, the most expensive city in Texas, is $196,600.

Recent buyers with low down payments would pay a bit more interest. Established owners with smaller mortgages (or no mortgage) have less in deductions.

If you download the NAR figures and sort the median home prices from highest to lowest you’ll make another interesting discovery. Only 21 of the 154 cities have median home prices over $237,500. If you examine the cities in that list you’ll find that 20 of the 21 are in California or the urban Northeast states.  Boulder, Colorado is the single exception.

There is much to discuss in these figures, but one thing is very clear. The deductions for mortgage interest and real estate taxes don’t have much to do with their original purpose, which was to encourage home ownership.