Tom Kelly: Few homeowners use mortgage interest deduction

The mortgage interest deduction is back in the news, thanks to a new tax plan being floated by the Trump administration. While any altering of the deduction has always been viewed as a slug to the midsection by a majority of homeowners, the number of taxpayers choosing to itemize – and thus use the deduction – is fewer than expected.

The mortgage interest rate deduction once was viewed as an enormous incentive of home ownership.

Taxpayers who chose to itemize their federal income taxes are able to reduce taxable income by subtracting the amount they paid in mortgage interest, which could be a significant amount, especially in the early years of a fixed-rate loan.

The MID, once felt to be “in stone” and a write-off that would never be eliminated, is now used by fewer than 30 percent of all taxpayers.

It is not a dollar-for-dollar deduction; rather the amount of interest paid reduces taxable income. It is usually contested in an election year when the opposition party brings an alternative to the table and is fought viciously by the National Association of Realtors, which spends millions of dollars lobbying to keep the MID in place.

In a nutshell, Treasury Secretary Steve Mnuchin said the mortgage interest deduction would remain but the number of people who would take it would be greatly reduced. That’s because the standard deduction would be increased to $24,000 from the present $12,600 for couples filing jointly and to $12,000 for single filers, up from $6,300.

Under the new proposal, even fewer taxpayers would itemize. That’s because their total itemized deductions would not exceed the standard deduction. For example, if a couple’s charitable deductions and mortgage interest totaled $23,500, they would not need to itemize and take the standard deduction of $24,000.

According to online real estate site Trulia, the financial advantage of owning versus renting under the new proposal would be reduced. Buyers most likely to be affected are middle-income households making between $68,540 and $129,422 who are looking to purchase a home between $358,000 and $676,000 and who take out a mortgage between $322,200 and $608,400.

According to Trulia, about 21.7 percent of the nation’s for-sale home listings on the market during the week the Trump administration announced the proposal were priced between the affected range of $358,000 and $676,000.

This suggests that homebuyers of over a fifth of homes currently for sale might not be able to take the MID if the tax proposal passes.

The present Internal Revenue Code allows mortgage interest to be deductible on an outstanding mortgage principal balance of a combined $1 million for a principal residence and one additional residence. In addition, interest payable on a home equity line of credit is limited to a loan balance of $100,000. Interest payments from money used to finance home improvements are not included in those ceilings.

What many taxpayers overestimate is their mortgage interest deduction in the later years of their loan. While the loan payment remains the same, fewer dollars are going toward interest and are therefore deductible. The percent of the payment made to the loan’s principal is not deductible.

In the 2012 election year, legislators and analysts from both parties threw stones at the once-untouchable tax benefit, considered by many to be a key incentive for home ownership, but nothing really changed even though data showed otherwise.

In an October 2012 survey, a majority of the nation’s leading economists, real estate experts and investment strategists said eliminating or drastically changing the mortgage interest deduction would benefit the country’s economic outlook. Only 11 percent of the 113 respondents said the MID should remain as-is.

In previous years, some of the more popular alternatives included eliminating the deduction entirely for second homes, converting the present MID to a 12 percent tax credit and reducing the $1 million ceiling to $500,000.

What has not come under serious discussion in the past six months is the ability to deduct the mortgage interest on a second home. Under current guidelines, consumers are able to deduct the interest on two residences – sometimes known as “The Congressman’s Rule” because many lawmakers keep a residence in their home state and another in the nation’s capital.

Accountants say that if the second home mortgage interest deduction is threatened, taxpayers could choose to rent out their homes for a period greater than their personal use and change the second home’s status to an investment property.

However, given the strength and sway of the NAR – the nation’s largest trade association – any change in the MID would be surprising.