BLOG VIEW: When it comes to tax deductions, the real estate industry has a winner: The mortgage interest deduction – or MID – is one of the great success stories in Washington, D.C., a tax benefit that represents the unassailable right of every American to write off real estate financing expenses and, thus, have a greater interest in real estate ownership.
That, at least, is the usual story. The reality is different: The MID is less secure than fairy tale stories suggest; in fact, one can argue that it’s within a hair’s breadth of extinction.
For decades, the U.S. government has been busy “reforming” the tax system, an expression that means adding special carve-outs for every industry and profession with a D.C. trade association and an aggrieved membership. Changes to the tax system are routinely made in the name of “fairness,” an undefinable term that often seems closely associated with political contributions and larger revenues for special pleaders.
The tax system as it now stands is set up to favor real estate ownership. If you own a home, you can write off mortgage interest and property taxes. Sell a prime residence, and you can shelter as much as $500,000 in profits from taxes if married, $250,000 if single. If you invest, you get to write off mortgage interest, property taxes, depreciation and operating expenses. If you hold investment property for at least a year, you can get the benefit of long-term capital gains rates when you sell.
Alternatively, if you rent, you’re allowed to write checks to your landlord; in fact, the owner will be offended if you don’t.
Although the present system is politically popular, it suffers from three problems:
First, it has not objectively produced much homeownership. The U.S. homeownership rate stands at 63.6%, a benchmark outdone by such bastions of capitalism as Romania (No. 1, with 96.4% private ownership); Russia (83.5%); and China (90%). Alternatively, according to columnist George Will, “Australia, Canada and the United Kingdom, which have no mortgage interest deductions, have homeownership rates comparable to America’s.”
Second, the taxpayers most likely to get deductions tend to earn substantial incomes. “In most cities,” says National Affairs, “tax filers with an income above $100,000 are between three and four times more likely to take advantage of the mortgage interest deduction than are taxpayers below that income level.”
Third, we have a government starving for cash, and the MID represents a juicy source of lost revenue – about $77 billion, according to the Pew Research Center. Add in another $34.7 billion in property taxes, and we’re talking big numbers, well over $100 billion in real estate-related write-offs.
Mortgage interest deductions
“There are now two tax reform initiatives circulating in Washington, D.C.: a one-page outline of the Trump administration’s tax plan and a 35-page proposal from Speaker Paul Ryan,” says Rick Sharga, executive vice president at Ten-X.com, an online real estate marketplace. “Both substantially increase the standard deduction and, at the same time, eliminate most itemized deductions, but not the mortgage interest deduction. And both have surprisingly significant implications for homeowners.”
“To simplify tax filings further for middle-income families,” says Ryan in his plan, “this blueprint reflects the elimination of all itemized deductions, except the mortgage interest deduction and the charitable contribution deduction.”
So, this means the MID is safe, right? Like much in Washington, D.C., you have to read between the lines.
“By doubling the standard deduction and repealing the state and local tax deduction,” says the National Association of Realtors (NAR) in an unusually strong statement regarding the president’s proposal, “the plan would effectively nullify the current tax benefits of owning a home for the vast majority of tax filers.”
If the proposed tax changes pass the tax difference between renting and ownership, ownership will be largely removed, especially for potential entry-level borrowers. For example, under the 2016 tax rules, a married couple filing jointly can get a $12,600 standard deduction. With the Ryan plan, the standard deduction for the couple would rise to $24,000 and $30,000 under the Trump proposal. No less important, the same standard deduction would be equally available to both renters and owners.
If one of the new plans becomes law, a model couple will have a choice – do they take the itemized deductions or the standard deductions? In March, the typical existing home sold for $236,400, according to NAR. With 100% financing at 4%, the first-year cost for mortgage interest is $9,380. Add in charitable contributions, and how many taxpayers will have $24,000 in itemized deductions, much less $30,000?
If the Trump or Ryan tax plan passes as currently written, relatively few people will elect to itemize deductions, which means relatively few people will care about the MID. This makes real estate ownership a lot less interesting. For instance, it breaks the sales chain because without first-time purchasers, large numbers of current owners cannot move away – or up. For the real estate industry – the brokers, lenders, lawyers, insurers, title companies, local tax collectors and others who depend on real estate transactions – the impact of the proposed plans is fewer sales and a far-smaller marketplace.
“Current homeowners,” says NAR President William E. Brown, “could very well see their homes’ value plummet and their equity evaporate if tax reform nullifies or eliminates the tax incentives they depend upon, while prospective home buyers will see that dream pushed further out of reach.”
The problem is actually more insidious: The big worry is not that buying will be delayed – it’s that potential purchasers won’t care; they won’t see ownership as attractive. After all, what yearly write-offs will renters gain from scrimping and saving for ownership if the tax proposals on Capitol Hill become law?
Peter G. Miller is a nationally syndicated real estate columnist. His books, published originally by Harper & Row, sold more than 300,000 copies. He blogs at OurBroker.com and contributes to such leading sites as RealtyTrac.com, the Huffington Post and Ten-X. Miller has also spoken before such groups as the National Association of Realtors and the Association of Real Estate License Law Officials.
