Mortgage interest deduction

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stannius
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Mortgage interest deduction

Postby stannius » Wed Sep 15, 2010 1:01 pm

In recent months I have come across an increasing number of comments in financial articles putting the mortgage interest tax deduction in a negative light. Various arguments were used to support this characterization, including but not limited to: The deduction costs the government $X billion dollars of lost tax revenue. Most of the benefit goes to the rich. Country Y doesn't have the deduction and their home ownership rate is still Z%. The deduction encourages home ownership, which as we all know is what lead the world's economies to their doom.

It seems to me that allowing mortgage interest to be deducted is necessary to provide a level playing field between renting and buying. Someone who buys a house and then rents it out would deduct the mortgage interest as a business expense, and legitimately so. So someone cutting out the middleman and buying their own house directly, should get that same cost break.

Am I wrong?

stannius
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Re: Mortgage interest deduction

Postby stannius » Wed Sep 15, 2010 1:26 pm

I think I may have the answer to my own question.

For a landlord, rents received are counted as income. Allowing deductible mortgage interest offsets that income.

For someone living in a house they own, the rent they are not paying to someone else is not counted as income. (Except in a few countries.)

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Re: Mortgage interest deduction

Postby DoingHomework » Wed Sep 15, 2010 1:39 pm

stannius wrote:In recent months I have come across an increasing number of comments in financial articles putting the mortgage interest tax deduction in a negative light. Various arguments were used to support this characterization, including but not limited to: The deduction costs the government $X billion dollars of lost tax revenue. Most of the benefit goes to the rich. Country Y doesn't have the deduction and their home ownership rate is still Z%. The deduction encourages home ownership, which as we all know is what lead the world's economies to their doom.

It seems to me that allowing mortgage interest to be deducted is necessary to provide a level playing field between renting and buying. Someone who buys a house and then rents it out would deduct the mortgage interest as a business expense, and legitimately so. So someone cutting out the middleman and buying their own house directly, should get that same cost break.

Am I wrong?


I've thought about the same thing and also noticed the discussion in the media about eliminating it. I think the discussion is driven by the need for the government to increase tax collections. If the deduction were eliminated then some think the government would collect more in taxes.

I'm not so sure. If the deduction were eliminated I think many people might sell their homes and rent. That would further depress home prices and the economy! It would also be extremely unpopular so I don't see Congress ever voting for that.

I also don't think many of the arguments make sense. If I had $1,000,000 and wanted to buy a house, I could pay cash and forego the deduction or I could borrow
money at 4%, get the deduction, and have an after tax cost of capital of around 3%. That would be attractive since I could then take my money and earn a higher return on it by saving or investing it. That is something the government encourages.

My benefit, the government's loss on the subsidy is about 1% of the value of the house I might buy, every year, though it declines. If I take the money and invest it to earn anything about 4% the government actually makes more money than it loses because of the takes I pay on that income (in round numbers with a few other caveats). The bottom line is that I think getting rid of the deduction would be largely revenue-neutral for the rich but it would be a huge loss for the middle class.

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Re: Mortgage interest deduction

Postby DoingHomework » Wed Sep 15, 2010 1:44 pm

stannius wrote:I think I may have the answer to my own question.

For a landlord, rents received are counted as income. Allowing deductible mortgage interest offsets that income.

For someone living in a house they own, the rent they are not paying to someone else is not counted as income. (Except in a few countries.)


A landlord gets to depreciate as well. That produces about 3.5% tax loss every year.

I have a rental. It gives me a good profit every year but after depreciation I (legally) have a tax loss that can soak up other taxable income in various ways, some immediate, some deferred.

If the mortgage interest deduction were eliminated I can already picture the clever arrangement that I could set up to benefit from the change. Basically I'd suddenly be able to depreciate my own house!

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Re: Mortgage interest deduction

Postby stannius » Wed Sep 15, 2010 3:08 pm

DoingHomework wrote:A landlord gets to depreciate as well. That produces about 3.5% tax loss every year.


True, but a homeowner gets tax free gains up to $250k per person. Eventually the landlord's depreciation must be paid back (though not necessarily at the same tax rate at which it was deducted of course.)

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Re: Mortgage interest deduction

Postby DoingHomework » Wed Sep 15, 2010 3:56 pm

stannius wrote:
DoingHomework wrote:A landlord gets to depreciate as well. That produces about 3.5% tax loss every year.


True, but a homeowner gets tax free gains up to $250k per person. Eventually the landlord's depreciation must be paid back (though not necessarily at the same tax rate at which it was deducted of course.)


Yeah. It's complicated. I once tried to work through the math very accurately. What I determined for myself was that it pays to own but only by about the amount of the tax benefit. So, if you buy a $200,000 house at 5% and pay $10000 a year in interest you end up getting roughly a $2500 "benefit." But you have to invest the down payment and accept illiquidity and debt so it is not necessarily an attractive return.

It depends on a lot of assumptions though and is probably location-specific. In Arizona, for instance, renters get a credit for half the property taxes paid by the landlord - there's a lot to that and it is partly to give renters incentive to identify landlords who are cheating both income and property taxes. But it amounts to about a 1% a year difference which is enough to skew the conclusion.

I know that in our situation with our second home as a rental we are able to earn money both from the rent we receive and the tax writeoffs. Someone is clearly paying for that. But if we did not get that kind of benefit we would not have bought and that would have in turn depressed prices...


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