Tuesday, June 8, 2010


There has been a lot written lately about whether or not to do away with the deduction on Schedule A for home mortgage interest.

Howard Gleckman posed the question “Should We Dump the Home Mortgage Interest Deduction?” at TAXVOX, the blog of the Tax Policy Center.

Kay Bell added her two cents to Howard’s commentary in “Is It Time to Kill the Mortgage Interest tax Deduction” at DON'T MESS WITH TAXES.

A recent tweet led me to the article “Mortgage Deduction: America's Costliest Tax Break” By Jeanne Sahadi at CNNMoney.com from April.

The CNNMoney article tells us that – “Between 2009 and 2013, the government will lose out on nearly $600 billion because of it, according to the Joint Committee on Taxation”.

{As an aside – the article also tells us that during the same period the Earned Income Credit will cost $261 Billion. Assuming that estimates are correct and at least 30% of all EIC claims are bogus that means $78 Billion tax dollars down the drain!}

Howard begins his post by asking the question “Do we want to use the tax code to subsidize home ownership?” Apparently Congress does – as they recently gave away up to $8000 of taxpayer money to just about anyone that purchased a personal residence.

First let us look at the current deduction for home mortgage interest -

The home mortgage interest deduction is not as simple as one would think. You cannot simply just add up the amounts on 1098s issued by mortgage holders and enter that number on Schedule A – although that is exactly what is done most of the time.

The deduction of interest on borrowing that is secured by a residence is limited based on type of debt – acquisition debt or home equity debt. And for purposes of calculating the dreaded Alternative Minimum Tax (AMT) home equity debt is not deductible.

Acquisition debt is debt acquired after October 13, 1987 to buy, build, or substantially improve your main residence or a qualified second home. A “substantial improvement” is one that adds value to the home, prolongs the home’s useful life, or adapts the home to new uses. The amount of interest that you can deduct on acquisition debt is limited to $1 Million ($500,000 if Married Filing Separately) of principal. Qualified acquisition debt also cannot exceed the cost of the home plus the cost of any “substantial” improvements.

Home equity debt – debt secured by a principal residence or second home that is not used to buy, build, or substantially improve the property. There is no restriction or limitation on what the money can be used for. You can use it to buy a car, pay down credit cards, or take a trip to Europe. The amount of interest that you can deduct on home equity debt is limited to $100,000 ($50,000 if married filing separately) of principal.

If you have combined mortgage debt of $850,000. and $600.000 is acquisition debt and $250,000 home equity debt, you can only deduct interest on $700,000 (assuming we are not talking about a separate return). If $800,000 is acquisition debt and $50,000 home equity borrowings, all of the interest is fully deductible. In either case only interest on $600,000 can be used in calculating the dreaded AMT.

It is possible to deduct some of the excess interest as investment interest if you can show that the money from the borrowing was used for qualified investment purposes.

FYI, when I first started to prepare taxes professionally all interest was fully deductible on Schedule A – auto loan interest, credit card interest, pension loan interest, personal loan interest, student loan interest, etc – regardless of one’s level of income and regardless of the amount of debt. Reagan phased out the deduction for “personal” interest in the Tax Reform Act of 1986 and created the new rules for deducting interest on “acquisition” and “home equity” debt.

In the years leading up to the recent financial FU, as the market value of one’s home increased unrealistically, and banks and mortgage companies were giving away money like crazy, homeowners would constantly refinance their mortgage and use the money, perhaps initially to make home improvements, but eventually to pay down credit cards, buy cars, pay for college, and so on. Often, unfortunately, once a credit card was paid down it was “charged up” again – resulting in additional refinancing to once again pay it down. It got so that the combined mortgage principal was as much as 2 or more times the original purchase price of the residence!

To be perfectly honest, in the 25 some years since the rules for deducting interest were revised I do not know of a single homeowner who voluntarily keeps contemporaneous documentation of the use of moneys received from multiple mortgage refinancing and home equity borrowings. I dare you to show me a taxpayer, other than one who still maintains his/her initial purchase mortgage, who can tell you to the dollar exactly how much of his total mortgage principal is acquisition debt and how much is home equity debt. If any of this is being done it is being done by we tax professionals after the fact and made up for the most part using best guess estimates.

There is obviously much abuse of the mortgage interest deduction as it is currently described in the Tax Code.

To be continued . . .



Anonymous said...

I had two mortgages on my house before. One loan was for the house and the other was for a business. Two separate mortgage loans was tracked. Obviously the business use of the mortgage was easy to track.

In addition, I think the rulers in DC should eliminate the mortgage interest deduction, only if they eliminate the AMT too.

VPK said...

One item to consider is how the value of the house will change if the interest deduction is eliminated.

Take a $500K home with a 80% LTV 5% 30-year mortgage owned by a family with a marginal tax rate of 28%. The monthly payment is $2,147. Over the period of the mortgage, the tax subsidy has a future value of $104,446, or a value in today's dollars of $63,755 (I used a discount rate of 5%, the same as the interest rate on the mortgage). The new value of the house is $500,000 - $63,755, or $436,245.

In other words, the current interest payment deduction has a value that is reflected in the sale price of the home, and elimination of the deduction would adversely affect every homeowner. While replacing the deduction with a credit may simplify implementation, there will certainly be winners and losers from any changes.

Victoria Mortgage Brokers said...

Thanks for a very nice post. Many are still confused with all these stuff and they end up being the loser in this.

Jazzie Casas said...

2010 was kinda a bizarre year for the mortgage market. In the first half of the year, you had a decent number of home sales keeping mortgages for purchases stable, thanks to the home buyer credit. In the second half of the year, that changed as demand crumbled when the credit was withdrawn. At the same time, you had very low mortgage interest rates throughout much of the year cause a mini-refinancing boom. 2011 will look very different, as the housing demand continues to struggle and mortgage interest rates have begun rising.

Personal Loan said...

I had 2 mortgages on my home before. Both loans i got for business.