The National Association of Home Builders
Q: The mortgage interest deduction is considered a cornerstone of American housing policy. How does it work?
A: The mortgage interest deduction helps make homeownership more affordable by allowing home owners to deduct the interest that they pay on the mortgage for their home when calculating their annual federal income tax. The mortgage interest deduction has been a part of the nation’s income tax code since its inception in 1913.
Q: Can you give me an example of how the deduction benefits a typical home owner?
A: Let’s look at a family with a joint income of $80,000 and a mortgage of $180,000. Assuming that the interest rate on the mortgage is 5.5 percent, the family will save $7,050 in taxes during the first five years of ownership. The amount of the deduction declines slightly each year as the amount of interest that the home owner pays drops and the portion of their monthly payment that is applied to the loan principal increases.
Q: What forms do I need to submit to the IRS to claim the mortgage interest deduction?
A: You will need to itemize on your tax return to claim the mortgage interest deduction. At the end of every year, your mortgage lender will provide you with a statement showing how much interest you paid during the year. The lender will also provide that statement to the IRS, so you do not need to send a copy with your tax return. However, be sure to keep that statement for your records.
Q: Is it true that only wealthy people benefit from the mortgage deduction? Who benefits most from the mortgage interest deduction?
A: Opponents falsely argue that the deduction is only for the wealthy. In fact, according to Congressional estimates, home owners with incomes of less than $200,000 receive nearly 70 percent of the tax benefit of the deduction.
Moreover, the deduction is most valuable for younger households who tend to be recent home buyers with large mortgages, small amounts of home equity and growing families. IRS data indicates that the largest deduction dollar amounts go to people aged 35 to 44. As a share of household income, the largest amounts go to those aged 18 to 34.
Almost 75 percent of the total deduction is claimed by those under age 55; those aged 35 to 44 claim 30 percent.
Q: How does the mortgage interest deduction make the tax code more progressive?
A: A tax system is “progressive” when higher-income taxpayers pay a higher average tax rate.
Sixty-eight percent of the tax benefit from the mortgage interest deduction goes to taxpayers with incomes under $200,000. However, these households pay only 43 percent of all taxes, so the deduction makes the tax code more progressive by reducing the average effective tax rate for these home owners.
Eliminating the deduction would increase the share of total taxes paid by those earning less than $200,000 and make the tax system less progressive.
Q: Is there a limit on how much mortgage interest a taxpayer can claim?
A: Home owners may deduct interest on up to $1 million of debt on a mortgage used to purchase a home and up to $100,000 in home equity loan debt. These limits were set in 1987, and they have not been adjusted for inflation since then.
Q: Can a home owner deduct the mortgage interest on more than one home?
A: Interest on the mortgage on a principal residence and a second non-rental home is deductible. This rule helps home owners who sell an existing home to buy a new home by allowing the owner to deduct the interest allocable to both homes in a given year.
Q: Can I claim the mortgage interest deduction on a construction loan used to build my home?
A: Yes, you can claim interest on a construction loan for up to 24 months while your new home is being built. Consult with your tax advisor or the IRS for details.
Q: What happens if I refinance my mortgage loan? Is the interest still deductible?
A: Yes, interest on a refinanced mortgage loan is deductible if the mortgage meets all of the other criteria for the mortgage interest deduction. Your tax advisor or the IRS can provide you with the specifics. Q: I have heard that only about 25 percent of all taxpayers benefit from the mortgage interest deduction. Is that true?
A: No, it is not true. Such a claim is misleading because it ignores the consumer’s “life cycle” of renting and owning homes. Most home owners will claim the mortgage interest deduction during their lifetime. Typically, a taxpayer will begin his/her working life as renter, become a first-time home buyer, claim the deduction, and then stop claiming the deduction after his/her mortgage debt is sufficiently paid down.
Near the end of a mortgage term, significantly less of the home owner’s monthly payment goes toward interest, so owners with older mortgages may find it to their advantage financially to take the standard deduction and not itemize.
The more relevant question is: What percentage of mortgage interest paid is claimed as a tax benefit? Since 2000, 86 percent of all mortgage interest paid by home owners has been claimed on income tax returns. Clearly, most home owners with a mortgage benefit from the deduction.
Q. Although the deficit reduction commission did not make a specific recommendation to Congress, its proposals are expected to shape the ongoing debate of U.S. fiscal policy. How would the proposal to eliminate the mortgage interest deduction and replace it with a 12 percent nonrefundable tax credit affect a typical home owner?
A. Suppose a home owner paying $10,000 in mortgage interest in a year faces a marginal tax rate of 25 percent and, to keep things simple, has enough other itemized deductions that they would itemize regardless of the mortgage interest deduction. For that home owner, the mortgage interest deduction is worth approximately 25 percent times $10,000 or $2,500 in reduced taxes paid.
With a 12 percent tax credit, the home owner’s tax benefit would be reduced to $10,000 times 12 percent or $1,200.
Moreover, if the other commission proposals went into effect, the home owners would not be able to deduct their state and local property taxes or the interest on any home equity loan they might have and they would pay higher tax on a principal residence when sold.
Q: I have always thought of the mortgage interest deduction as being very important, and I would oppose any effort to eliminate it or limit it in some way. What do other people think about eliminating or altering the mortgage interest deduction?
A: Americans overwhelmingly oppose any action by Congress to tamper with the mortgage interest deduction. Seventy-nine percent of voters polled by Public Opinion Strategies, a national political and public affairs research firm based in Alexandria, Va., said they support retaining federal tax incentives to promote homeownership.
Both home owners and renters were polled in the September 2010 survey, and support for the mortgage interest deduction cut across gender, age, partisan, ideological, education and regional lines.
Q: How many of the renters who were polled said they support homeownership tax incentives?
A: A slightly higher percentage of renters – 82 percent – indicated that they favor providing tax incentives to promote homeownership. Among the renters who were polled, 58 percent said they have used the mortgage interest deduction in the past or hope to use it in the future.
In ranking the importance of current deductions, renters indicated that the mortgage interest deduction is second in importance only to the deduction for medical expenses. (72 percent vs. 71 percent).
Many renters expect to become home owners, so this support for the mortgage interest deduction is natural given the high share of interest payments these buyers will make in terms of their total monthly mortgage payment.
Q: What would happen if Congress eliminated the mortgage interest deduction or limited it in some way?
A: Home owners do not expect to lose their mortgage interest deduction, and prospective buyers anticipate taking the deduction. Changing “the rules of the game” would have a significant impact on the market in terms of home owner and home buyer behavior.
As a result, after-tax housing costs would increase, and demand for housing would decrease. In turn, reduced demand would depress home prices, producing a sizeable loss for existing home owners. With housing markets already struggling due to the ongoing effects of the recession, such a change in home values could weaken the economic recovery and perhaps drive the nation’s economy back into recession.
Q: Are there any other housing-related provisions in the tax code that home owners should be aware of?
A: Yes. State and local real property taxes paid for a home are deductible, and so are interest payments for home equity loans. Half of the total dollar amount of home equity loans is used to remodel or improve existing homes.
The tax code also includes a capital gains exclusion that allows home owners to exclude from tax all or part of any gain from the sale of their principal residence (in most cases, all of the gain). Provided they have owned and lived in the home for at least two years and meet certain other requirements, married home owners can exclude up to $500,000 of gain from the sale of a principal residence. Single home owners who meet the same ownership and use criteria can exclude up to $250,000 from tax.
The deficit commission’s proposal also included eliminating the deduction for property taxes, the capital gains exclusion, and the deduction for interest on home equity loans. Elimination of any or all of these measures would have a significant effect on individual home owners, the housing market and the nation’s economy.
Q. Are there any provisions in the tax code that benefit renters?
A. Yes. Two provisions in the tax code provide indirect benefits to renters.
The Low-Income Housing Tax Credit or LIHTC facilitates the construction of rental properties that provide affordable housing. The program is highly effective and has resulted in the construction of 2.3 million affordable rental units since it began in 1986.
The 27.5-year depreciation period for residential rental housing allows owners to accurately reflect for tax purposes the reduction of value of a capital asset, such as an apartment building, as it ages. A depreciation period that mirrors actual economic depreciation helps building owners manage cash flow. In turn, the owners then pass these tax savings on to tenants in the form of lower rents. Allowing owners to claim depreciation on residential rental properties also encourages construction of new units. The depreciation period for non-residential commercial properties is 39 years, and if the 27.5 year rule was repealed, the depreciation period for residential rental properties would likely increase to 39 years.
The deficit commission proposal included eliminating both of these provisions.
Q: I've heard that other countries don't have a mortgage interest deduction, but have similar homeownership rates. Is this true?
A: Comparing a single tax rule with homeownership rates across countries can be misleading because homeownership rates are influenced by many variables, including the average age of the population, the average income, urbanization rates, and finance/tax rules. All of the relevant variables need to be accounted for to make an apples-to-apples comparison.
Moreover, some countries have “backdoor” interest deductions, such as the so-called Smith Maneuver in Canada, which inefficiently and unfairly limits a mortgage interest type of deduction to only the wealthy or financially sophisticated.
The bottom line is that repealing the mortgage interest deduction in the United States would act as a “tax” on existing home owners by decreasing home values, and would increase the after-tax cost of purchasing a home with a mortgage.
Q: What can I do to make sure that Congress doesn’t tamper with the mortgage interest deduction and other housing-related tax code provisions?
A: Most important, let your Senators and Representatives know that you oppose any change to the tax code that would alter the mortgage interest deduction or any of the other tax code provisions that benefit housing.
You can also help spread the word. The majority of the nation’s households – almost 70 percent – are home owners, and most would be negatively affected if the mortgage interest deduction was eliminated or cut back or if other housing-related provisions in the tax code were eliminated. Everyone needs to be warned about this serious threat.
Stay informed about the threat to the mortgage interest deduction and other housing provisions in the tax code: