Mortgage interest deductions are an effective way to reduce your tax payments. Introduced as an incentive for people to own their own homes, these perks have become a staple for the modern American homeowner.
This tax deduction allows you to subtract the interest you pay on your mortgage loan from your taxable income. It also offers an effective way to cut down on your expenses. Even better, mortgage interest deductions are allowed for a maximum of two homes. And if you own more than two homes, you can change which of these is designated as your secondary residence.
Mortgage interest deductions can also be deducted for properties that you rent out. However, in order for the rental property to count as a second home, you need to spend more than 14 days (or at least 10% of the days that it is rented out) in the home every year.
As you can see, mortgage interest deductions aren’t unlimited. Generally, you are eligible for a mortgage interest deduction if your mortgage falls into any of these categories.
- You took out a mortgage that totaled less than $1 million (or $500,000 if you are married and wish to file separately) throughout the year to buy, improve, or build your main home
- You took out a home equity debt to the tune of $100,000 ($50,000 if you are married and wish to file separately) or less.
So Who Uses It?
You would expect that most homeowners benefit from this deduction. However, as research reveals, that is not the case. A recent report by the Pew Charitable Trusts shows that the popularity and benefits of mortgage tax deductions are unevenly distributed across the country. Instead of being used evenly, these perks are more popular in parts of the country where people have relatively high incomes (which places them in higher tax brackets and allows for higher deductions).
In areas where income and property values are low, the benefits are less noticeable. For instance, within Louisiana and Mississippi, less than 17% of the people filing for tax included this deduction. However, in states like Connecticut and Maryland, this percentage was much higher, with roughly 35% of homeowners claiming this benefit.
The study also revealed that the average mortgage deduction was as high as $4,580 per filer in Maryland – almost three times the deduction filed by homeowners in North Dakota. Deductions also vary randomly within states. Individuals in densely populated areas appear to benefit more. For example, within Austin, Texas, the claim rate was about four times that of people living in Odessa, Texas.
Why the Difference?
One of the major reasons why current mortgage interest deduction usage rates appear skewed towards high-income owners is the way it is calculated. Under current tax laws, the deduction is affected by the homeowner’s top tax rate. Because of this, individuals with incomes of $100,000 and above are able to enjoy bigger deductions.
Mortgage interest deductions also appear to be affected by the housing market within each area. For instance, homeowners who live in dense urban metropolitan areas – such as San Francisco – get to benefit from high tax breaks. And since the market experiences frequent turnovers, owners also get to enjoy higher deductions than they would from a more stable market. The uneven advantage for wealthy taxpayers has led to several people within the country calling for a restructuring of how deductions are itemized.
The Treasury Deficit
According to a PEW report from 2011, mortgage interest deductions reportedly cost the U.S treasury more than $73 billion in lost revenue. This figure is only slightly higher than the $68 billion the treasury lost in 2012.
Since the publication of the report, there have been several attempts to adjust or overhaul to reduce the federal deficit. The challenge, however, is finding an option that does not drastically affect the economy. No one denies the obvious benefit of tax breaks. But odds are that if the country had the opportunity to go back in time, they likely would not have created it again.
Changing the Interest Deduction
The general consensus seems to be something needs to be done. Current suggestions include replacing mortgage deductions with a credit, capping itemized deductions or limiting deductions to only first homes. The possibility of mortgage interest deductions being eliminated altogether is not likely. If the tax breaks were suddenly removed, it would almost definitely lead to a sudden spiral of panicked buying and selling – which would cause the market to crash all over again.
Any solution introduced by the government will need to be one that offers a gradual reconciliation of the current deficits between different classes. Some economist propose reducing the upper limit on mortgage interest deductions to $700,000 (from $1 million), and then dropping this value further by $25,000 every year. At this rate, the subsidy would be gradually phased out over a three-decade period.
To even out benefits across different income tax brackets, deductions could also be capped at 28%. This approach would give low income tax payers a better break, maintain the current benefits enjoyed by the middle class and only gradually reduce the subsidy of the high-income earners. In the same vein, the value of this deduction could be reduced by a percentage each year, so that it ends in 28 years.
Of course, all these options are mere conjecture at this point. The government has yet to announce what its stand on future mortgage deductions is going to be. The only thing that’s certain is that something will be decided before the end of the year. Until that happens, you might as well take full advantage of the current mortgage deductions as they stand!