Recent talk about tax reform has many homeowners wondering whether the mortgage interest tax deduction is here to stay. Like many answers to tax questions, it’s complicated. Let's start at the beginning.
The history of the mortgage interest deduction
The first modern federal income tax law was passed in 1894 but was subsequently struck down by the United States Supreme Court. In 1913, when the Constitution was amended and the new federal income tax was enacted, all forms of interest were tax deductible. It’s a bit strange to think of people as businesses but the idea was that if businesses could deduct certain expenses from their income, the same should be true for individuals. Interest is an expense, and so it came to be that all interest (not just mortgage interest) was deductible.
At the time, most homeowners didn’t have mortgages and therefore most people didn’t have interest to deduct. It was not until the 1930’s that home mortgages became widespread with the creation of the Federal Housing Administration (FHA) and Federal National Mortgage Association (FNMA), which insured 30-year loans.
As time passed, consumer debt became more available. In the 1970’s credit cards became popular and the amount of interest deductions ballooned. The Treasury determined it was time to close the loophole. And finally, in 1986, Congress ended the deductibility of interest. However, the mortgage interest deduction was preserved. In the words of President Reagan addressing the National Association of Realtors, "I want you to know that we will preserve the part of the American dream which the home-mortgage-interest deduction symbolizes." 1
The mortgage interest deduction today
Economists often argue whether the mortgage interest deduction is effective at promoting homeownership. Yet, the mortgage interest deduction is considered one of America’s most sacrosanct tax breaks, and it appears politically untouchable.
Under current tax law, if you itemize your deductions when you file your taxes, you can deduct the interest that you pay on up to $1 million of loans secured by your home. 2
Generally, deductions reduce the amount of income on which you are taxed. Each year when you file your taxes, you can choose to either itemize deductions (including mortgage interest) or claim what is known as the standard deduction. If you claim the standard deduction, you cannot also itemize deductions. You would likely opt to take the larger deduction. Under the current tax code, the standard deduction Americans can claim is $6,300 for individuals or $12,600 for married couples filing jointly.
President Trump’s tax proposal released this week includes some major changes to the federal tax code. The big question for many homeowners is, what happens to the mortgage interest deduction? In short, under the plan, the mortgage interest deduction would be preserved. However, fewer people would be expected to use it because the plan also proposes an increased standard deduction – from $6,300 to $12,000 for individuals and from $12,600 to $24,000 for married couples. 3
Currently, less than half of homeowners use the mortgage interest deduction. 4 If this proposal becomes law, likely even fewer homeowners would itemize deductions because more taxpayers would opt for the higher standard deduction.
If itemized deductions become less relevant, there may be less incentive to own rather than rent. These proposed changes have many economists and real estate investors trying to determine how the tax plan might impact the real estate market and home prices. Expect a lively debate. We will be watching closely.
The above article is intended to provide generalized information. It does not give tax, investment, legal, or other advice. Before taking any action, you should always seek the assistance of a professional.