Mortgage Interest Deduction Faces Scrutiny

Some of the biggest news out of Washington, D.C., recently revolves around a new proposal to overhaul the U.S. tax code  . Congressional lawmakers from the Republican Party introduced the first draft of a hotly anticipated bill Nov. 2 that many say would make the most expansive changes to U.S. tax law seen in decades. With broad support from members of the House of Representatives, the Senate, the White House and many business groups, the changes could slash tax bills for many corporations and families. However, it also proposes several specific and controversial changes, many of them involving the deductions and exemptions taxpayers can claim on their annual returns. One of the most widely debated proposals centers around the mortgage interest deduction.

Background on the rule

Under current rules, the IRS allows taxpayers who file an itemized return to deduct the cost of interest paid on mortgages valued at up to $1 million for married couples filing jointly. If the new tax legislation is signed into law, that limit will be reduced to $500,000.

The New York Times reported that the mortgage interest deduction is not commonly utilized  among Americans in general - less than 3 percent of U.S. mortgages are valued at more than $500,000. However, the deduction is more popular in cities where homes are more expensive than average. For example, while only 6.5 percent of homes in Houston, Texas, exceed the $500,000 mark, around 63 percent of homes in San Diego, California, are over the limit.

Without the deduction at its current ceiling, the overall cost of buying a home is expected to increase. That's why many homebuilding corporations as well as homeowners and real estate interest groups have come out against the plan. But the mortgage interest deduction has long been opposed  by many groups, too, including economists and lawmakers from both sides of the political spectrum. That makes it one of the most uniquely contentious pieces of an already controversial bill.

Arguments for and against

The mortgage interest deduction is directly beneficial to certain homeowners as well as many businesses. A report from the Joint Committee on Taxation estimated that it reduced federal tax revenue - and therefore taxpayer bills - by $77 billion in 2016. Since only a small chunk of Americans could actually take advantage of the tax break, it's easy to imagine that it could shave thousands off an individual's taxable income. Without it, the cost of buying a home would effectively rise.

Anything like this that could reduce the incentive to purchase a home has many in the real estate industry worried. Ever since the bottom fell out from the U.S. housing market during the 2008 recession, companies involved in home construction and sales have been fighting to adapt to a changing market. Fewer Americans are purchasing homes in general compared to previous decades, and prices have been pushed higher. Those who are buying homes, in high-value and luxury markets, make up a higher proportion of the real estate industry's income. If the tax break on mortgage interest was reduced, this high-end segment would be the hardest hit.

"We are currently reviewing the details of the tax proposal released today, but at first glance it appears to confirm many of our biggest concerns," William E. Brown, president of the National Association of Realtors, said in a statement. "Eliminating or nullifying the tax incentives for homeownership puts home values and middle-class homeowners at risk, and from a cursory examination this legislation appears to do just that."

However, Brown's second point about middle-class homeownership is debated among policy experts. The mortgage interest deduction has already survived numerous attempts at elimination over the years, with some arguing that it unfairly incentivizes homeownership for wealthier individuals but does little for the majority of taxpayers. For this reason, some analysts support this specific part of the Republican tax bill even if they are staunchly against the rest of it.

The current proposal doesn't win among everyone who wants to see the mortgage interest deduction repealed, though. Economist Edward Glaeser told the Times that he was generally in favor of unraveling the deduction, but did not support its grandfather clause that would preserve the tax break for already-existing mortgages. According to Glaeser, this would discourage homeowners from moving and thus make for a less dynamic economy in general.

It remains to be seen if the mortgage interest deduction will be reduced at all as the bill continues to move through the legislative process. Of course, there's a chance that the tax bill won't pass at all. In any case, it's important for homeowners to understand how such a change might impact them in the future.