Tuesday, June 28, 2011


Currently a taxpayer can deduct on Schedule A either state and local income taxes, including employee contributions to state unemployment, disability and family leave funds, or state and local sales taxes, real estate taxes on all property held, personal property taxes, foreign taxes, mortgage interest, including points, on acquisition debt and home equity debt on two personal residences, mortgage insurance premiums, and investment interest.

There has been talk of doing away with the deductions for real estate taxes, state income taxes, and mortgage interest. My new Tax Code would allow an itemized deduction for state and local income taxes, real estate taxes paid on the taxpayer’s primary personal residence only, and mortgage interest on acquisition debt only for the primary personal residence only.

So taxpayers who itemize would be able to deduct state and local income taxes paid, including state fund withholdings, and the real estate taxes and acquisition debt interest on the home in which they live.

There would be no current deduction for real estate taxes on any other real estate held by the taxpayer. Real estate taxes on vacation homes would be considered a personal expense and non-deductible. Real estate taxes on rental property would continue to be deductible as currently allowed on Schedule E. Real estate taxes on property held for investment, such as vacant lots or houses purchased to be “flipped”, would be capitalized and added to the cost basis in determining gain or loss. There would be no deduction for personal property taxes. Foreign tax paid would be allowed as a credit only, direct from a Form 1099 or K-1 and without the need for a Form 1116, regardless of the amount of the foreign tax paid.

Only interest on “acquisition debt” – money borrowed to buy, build or substantially improve a taxpayer’s primary personal residence, and secured by the residence - would be deductible. There would be no deduction for mortgage interest on a second personal residence or for interest on home equity debt not used to substantially improve one’s primary personal residence.

Interest on home equity borrowing would be allowed on Schedule C, E or F if the money borrowed was used for business or rental purposes, using the current “follow the money” tracking rules.

This would require special new rules and regulations for banks and mortgage companies for issuing home-secured loans.

A “mortgage” loan would only be permitted for “acquisition debt”. Interest on a “mortgage” for a taxpayer’s primary personal residence would be fully deductible, up to the current acquisition debt limitations. “Home equity debt” would have to be a totally separate loan, and interest on this type of loan would not be deductible. A Form 1098 would only be issued for interest paid on a “mortgage” loan, and the bank or mortgage company would be required to report only interest paid on up to $1 Million of principal, and indicate if the mortgage was secured by a primary personal residence.

One would not be able to refinance a home-secured loan to include both types of debt in one loan. Therefore a homeowner could not refinance a “mortgage” to get additional money in hand unless he/she could prove to the lender that the money is used to “substantially improve” the secured residence. One would have to refinance the “mortgage” for the exact same principal, adding perhaps related closing costs, and take out a separate “home equity” loan to get any money in hand.

By instituting these requirements a taxpayer, or his/her preparer, would truly be able to just take the amount of mortgage interest reported on the Form 1098 for the primary personal residence and transfer it to Schedule A.

Points on acquisition debt for a taxpayer’s primary principal residence would be deductible as mortgage interest – but would have to be “amortized” over the life of the mortgage in all situations. Points paid on the purchase of vacation or investment property would be capitalized and added to cost basis in determining gain or loss when sold.

Why would I allow these deductions in the new simple and fair Tax Code?

The Internal Revenue Code taxes Americans based on income measured in pure dollars. However it is a fact that the “value” of one’s level of income differs, sometimes greatly, based on one’s geographical location. A family living in the northeast (New York, certainly New Jersey, Connecticut) or California that has an income of $150,000 may be just getting by, while a similar family that resides in “middle America” lives like royalty on $150,000. Many components of the Tax Code are indexed for inflation, but nothing is indexed for geography. To be honest I have no idea how one would even begin to index for geography.

It costs an awful lot to live in, for example, New York, certainly New Jersey, Connecticut, and California. State and local income and property taxes are the highest in the country. The cost of real estate is also excessively high. As a result one must earn a lot more money to be able to live in these states – and salaries are arbitrarily increased to reflect the increased cost of living. Yet $150,000 in income is taxed by the federal government at the same rate in New York City as it is in Hope, Arkansas.

Taxes and the cost of a home, and therefore also the amount of “acquisition debt” mortgage interest paid on a residence, are higher in the Northeast, and California. Since we pay taxes on “net income” after deductions, allowing an itemized deduction for these items would help to somewhat geographically “equalize” the tax burden.

No deduction would be allowed for mortgage insurance premiums in any circumstances. This deduction should never have been allowed in the first place.

As of this writing I think I would keep the itemized deduction for investment interest as it is under current law, and continue to limit it to net investment income. Home equity interest could be deductible as investment interest under current tracking rules.



dbltall said...

Could you run for Congress? Or get on a tax reform committee? Because this is more sensible than anything I've ever seen Congress do to the tax code.

All I can think of is to have all laws sunset automatically after 10 years or so, to make them spend their time reviewing the laws we've already got instead of constantly making up new stuff.

Robert D Flach said...
This comment has been removed by the author.
Robert D Flach said...


Sorry for the above FU. Let's try again.

Thanks for the kind words.

"Sunsetting" wouldn't work. The idiots in Congress had ten (10) years to fix the Tax Code, but did nothing but sit on their arses.

As for running for Congress - somehow I do not think I would fit in. For one thing, I am not an idiot.

Thanks again!


Professor Nellen said...

All good points. Thanks for linking this to my recent post about the mortgage interest deduction (http://21stcenturytaxation.blogspot.com/2011/07/mortgage-interest-deduction-is-subsidy.html). I think if more people understood how the current mortgage interest deduction worked, they would also push for reform (such as to only allow a deduction for debt on a principal residence; or perhaps a credit instead).

So far as a tax deduction, arguably, it is justified to prevent a tax on a tax and to reflect that the money used to pay state taxes is not available to pay federal taxes. For more on that see - http://www.cpa2biz.com/Content/media/PRODUCER_CONTENT/Newsletters/Articles_2008/Tax/goodbye.jsp. AMT reform though, might lead to a reduction or loss of the state tax deduction. That would not be the way to go. Reduction or elimination of other deductions and credits would likely make more sense (for example the duplicative child credit and dependency exemption could be reformed).

Steve Visek said...

Interesting reading...thanks for your site. I do disagree with allowing deduction of mortgage interest because the lower tax revenues would require a higher tax rate to offset it. Thus someone who has a big mortgage is rewarded at the expense of those who have bought a less expensive home and paid it off.

If couple A put down $30k(5%) on a $600k house and have a big $570k mortgage for 30 years, and couple B lives more frugally and saves more and then puts down $60k(20%) on a $300k house and have a $240k mortgage for 15 years and then make extra payments and pay off their house in seven years, everyone, including couple B, pay a higher income tax rate to give couple A their mortgage deduction for 30 years.

Renters saving up to buy a home likewise subsidize the folks with the big mortgage.

Why should we use the tax code to reward those who take on big debt?