They are the most treasured of all the sacred cows in taxation. Threaten them, and you will be reviled. Mention that they are becoming irrelevant, and your sanity will be questioned.
Yes, Iím talking about home mortgage interest and real estate taxes as beloved itemized deductions. Iím also saying that it is time for them to go.
The notion of eliminating the deductions for home mortgage interest and real estate taxes, two of the largest tax breaks we consumers have, came to mind after I examined the stunning data for housing affordability. I realized that losing the deductions would affect only a few areas of the country and a small segment of the population.
Hereís the basic case:
The Federal Reserve has given homeowners a bigger break than the IRS ever will. How can this be? Simple. Back at the peak of the housing bubble, home mortgage rates averaged 6.82 percent. Today, rates are running about 3.57 percent, a decline of 48 percent. Since most of us get a tax benefit of 15, 25 or 28 percent on our interest deductions, riding the home mortgage refi gravy train over the last six years has been a lot more valuable than any tax break.
If youíve ridden that big payment reduction train, I have a suggestion. Rather than sending a thank-you note to Federal Reserve Chairman Ben Bernanke, take a senior citizen to lunch and express your gratitude. Your lower interest payment has come out of the yield on her savings. In this kind of thing there is no free lunch. And youíre the one who now has the money to pay for lunch.
Another implication is that if we really want to simplify our tax code ó reducing deductions as a way to get the lower tax rates the Simpson-Bowles commission suggested ó this is the time to do it.
The standard deduction is so high most homeowners donít benefit from itemizing. One of the things the fans of itemizing mortgage interest and real estate taxes seldom recognize is that you benefit only when your deductions exceed the $12,200 standard deduction on a joint return and $6,100 on a single return. So while everyone has kind thoughts about the beauty of home-related tax deductions, the reality is that lots of people donít have much in other deductions, either. Medical deductions are limited. Charitable contributions are smaller than weíd like to think. Basically, shelter deductions are the ball game unless you live in a state with a punishing income tax.
So letís do the math. At current mortgage rates and with a real estate tax equal to 1 percent of market value, youíd need to own a house worth more than $316,000 before you would begin to enjoy a reduction in your income tax. (This assumes a 20 percent down payment.) Raise the real estate tax rate to 2 percent of market value, and you get there at a lower home value, $251,000. Since most homes are taxed at 1 percent to 2 percent of market value, there is no tax benefit for homes of lower value.
Now examine median existing home sale prices across the country, as compiled by the National Association of Realtors. Of the 154 reporting metropolitan areas in a recent report, 14 had median home sale values of more than $316,000. Only 19 had median home sale values of more than $251,000. Add sly little facts like the reality that many people didnít buy their homes yesterday and have more than 20 percent equity. Or that an impressive 30 percent have no mortgage, and the benefit of itemized home deductions really isnít all itís cracked up to be.
The deductions are important only in what might be called ďthe usual suspect citiesĒ ó places such as San Jose/Sunnyvale/Santa Clara, Calif.; Honolulu; San Francisco/Oakland/Fremont, Calif.; Anaheim/Santa Ana/Irvine, Calif.; and New York/Wayne/White Plains, N.Y. These places had median sale prices from $467,800 to $673,000. In those areas the tax breaks to offset the cost of shelter compensate a bit for the most punishing state income taxes in the country.
The mortgage and real estate tax deductions have become perverse incentives. While tax breaks in high-cost areas allow some upper-middle-income households to own houses, the tax breaks have nothing to do with what Congress originally intended, which was to increase the rate of home ownership for the middle class.
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