Every April as Americans file their personal income tax returns, they breathe a collective sigh of relief when they get to the section where they can deduct the interest they paid on their mortgage. In fact, the Mortgage Interest Deduction – or MID – is one of the biggest federal government distributions, only behind the deduction for health insurance costs and now saving homeowners more than 0 billion each year.
What are the tax rules for the Mortgage Interest Deduction?
Once again, check with your CPA or tax professional, but per the IRS website:
https://www.irs.gov/Credits-&-Deductions/Individuals/Deducting-Home-Mortgage-Interest
Homeowners may deduct interest from up to $1 million of mortgage purchase debt and up to $100,000 of home equity loan.
Only mortgages for a principal residence and non-rental vacation home qualify for the MID, but not income-producing or rental properties.
The MID is beloved by homeowners – and respected by politicians.
Since it’s inception, the Mortgage Interest Deduction (MID) has been one of the most popular and protected pieces of legislation. In fact:
71% of those surveyed oppose eliminating the mortgage interest deduction
63% oppose limiting the mortgage interest deduction
The support is bipartisan: 69% Republicans, 64% independents, and 57% of Democrats oppose
73% of likely voters think it is reasonable to support housing through the tax code
Thanks to it’s near-sacred status with constituents, few politicians have called for the MID’s demise, though a few have been outspoken about reform. A brave (or unwise) few have called for the mortgage interest deduction to end, providing a new wave of funding for the federal government. Republican Presidential candidate Ben Carson is the latest to do so. But the MID has still has survived every round of tax cuts over the last couple decades, with strong lobby groups like the National Association of Realtors leading the charge to maintain the status quo.
So how much does the MID really save homeowners – or cost our government?
Studies reveal that the average homeowner with $54,000 in taxable income can deduct around $7,500 in mortgage interest during their first five years of owning a home. If we extend that to the first 12 years of home ownership, the average person can deduct about $17,000.
According to Treasury Department estimates, the MID saves homeowners $86 billion annually in recent years and probably will top $100 billion this year. The savings are also far reaching, as since 2000, 86% of mortgage interest paid has been claimed as a deduction on tax returns thanks to the MID.
How did the Mortgage Interest Deduction come about?
The first modern federal income tax in the United States was initiated in 1913. In those tax codes, all forms of interest were deductible, as the majority of the population owned or worked at small farms so it was difficult to differentiate personal versus business expenses. There was no specific push to make mortgage interest deductible, since few people had mortgages but just owned their homes outright after paying cash. In fact, Congress was probably aiming to help farmers and business owners more than homeowners since the tax excluded the first $3,000 ($4,000 for married couples) of income and less than 1% of the population earned more than that.
With the advent of the automobile in the 1920s, the dynamic of the country changed rapidly, and there were soon more home mortgages than farm mortgages. The movement to aid homeowners with mortgages was given a huge boost in the 1930s – the wake of the Great Depression, when governmental agencies like the Federal Housing Authority (FHA) came about, insuring 30-year loans, as well as the Federal National Mortgage Association, or Fannie Mae.
As the population exploded post WWII, there was a huge demand for family housing in the suburbs, so the benefit of a mortgage interest tax deduction was first used to promote the idea of home ownership.
Does the Mortgage Interest Deduction affect housing prices?
Although it’s almost impossible to measure, there is a direct positive impact from the MID and homeownership. Furthermore, since the federal government doesn’t want to be in business of providing housing for our large population, the MID provides incentives for people to buy their homes, saving money compared to renting. (There are other great tax breaks for landlords who own rental properties.
If the MID was cut from the tax codes, the fallout would be felt by tens of millions of families across the country. In fact, a Tax Policy Center study found that limiting mortgage interest deductions to a 28% maximum rate could cause metropolitan housing prices to fall by more than 10%. If the MID was revoked, the hit to consumer confidence could cause far-reaching damage to the housing market, and then the economy as a whole.
Who benefits the most from the MID?
90% of homeowners who benefit from the MID make less than $200,000 in annual income. And estimates show that two-thirds of MID benefit dollars go to those making less than $200,000 a year. Studies show that the tax savings is most valuable for younger households and newer homeowners, who have limited income, small amounts of equity, and increasing expenses due to growing families. IRS data reveals that largest total deduction amounts are for those aged 35 to 45; and as a share of household income, the largest amounts are for those aged 18 to 35.
Do the wealthy or middle class save more?
However, there is some controversy as to whom that MID really helps. Economists call the MID a regressively distributed benefit, pointing to the fact that the MID benefits wealthy Americans more over time since the wealthier you are the bigger your mortgage amount (generally) and your tax bracket is higher, which means the total deductions are larger.
To cite an example from the Center on Budget and Policy Priorities:
“A banker with a $1 million mortgage paying $40,000 in interest gets a government housing subsidy of $14,000 every year; he pays 65 cents of every interest dollar on his mortgage, while the government pays the other 35 cents. On the other hand, a nurse who makes $60,000 a year and pays $10,000 a year in interest will only get a $1,500 subsidy; she’ll pay 85 cents of every interest dollar on her mortgage while the government will pay the other 15 cents.”
But other analysts like the NAHB point to the fact that the MID is actually more valuable to the middle class, or households with incomes below $200,000. “For taxpayers earning less than $200,000, it is worth 1.76% of AGI; more than $200,000, value drops to 1.5% of AGI.”
But no matter if homeowners are wealthy, middle class, or of humble means, the Mortgage Interest Deduction is the most utilized and beneficial tax break they’ll ever get.
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Do you have questions about the tax benefits of owning a home or keeping a mortgage? Please contact us!