HISTORY Prior to the Tax Reform Act of 1986 all interest payments on personal debt was tax deductible The Tax Reform Act of 86 amended the Internal revenue code to disallow deductions for all personal interest except for interest on indebtedness secured by a first or second home In the Omnibus Budget Reconciliation Act of 1987, Congress further restricted the deductibility of mortgage interest HISTORY CONT. Interest distinguished as deductible included interest on acquisition indebtedness and interest on non acquisition indebtedness The amount deductible for Mortgage interest was limited to $1,000,000 ($500,000 for married filing separately) The amount deductible for Home equity loan interest was limited to $100,000 ($50,000 for marries filing separately) HOW IT WORKS Home owners may deduct a number of expenses related to housing as itemized deductions in computing taxable income You can deduct home mortgage interest only if you meet all the following conditions You must file Form 1040 and itemize deductions on Schedule A (Form 1040) HOW IT WORKS CONT. You must be legally liable for the loan. You cannot deduct payments you make for someone else if you are not legally liable to make them. Both you and the lender must intend that the loan be repaid. In addition, there must be a true debtor-creditor relationship between you and the lender. The mortgage must be a secured debt on a qualified home Is your interest fully deductible? HOW IT WORKS CONT. Does your home qualify? How to deduct upfront interest payments (points) If you paid $600 or more of mortgage interest (including certain points) during the year on any one mortgage, you generally will receive a Form 1098, Mortgage Interest Statement, or a similar statement from the mortgage holder. The statement for each year should be sent to you by January 31 of the following year. A copy of this form will also be sent to the IRS. HOW IT WORK CONT. How To Report See Handout For More Detailed Instruction Visit: http://www.irs.gov/publications/p936/ar02.html 1
Who Benefits from the Home Mortgage Interest Deduction? Many people thought that the home mortgage interest deduction is vital to lowand middle-income family budgets. An analysis of data from the Interest Revenue Service (IRS) tells a different story. Recent IRS data shows low- and middle-income taxpayers filed tax returns with under $30,000 in adjusted gross income (AGI) in 2003 received just 9% of deductions for home mortgage interest. In contrast, 36% of home mortgage interest deduction were claimed by taxpayers with AGI over $100,000. Home Mortgage Interest Deduction Disproportionately Benefits Upper-Income Taxpayers, 2003 Factors Affecting the Distribution Adjusted Gross Income Under $20,000 $20,000-$29,999 $30,000-$39,999 $40,000-$49,999 Percent of Home Mortgage Interest Deduction Claim 4.2% 5.1% 7.2% 7.9% Percentage of All Tax Returns in Income Group 37.8% 14.1% 10.7% 8.0% Average Mortgage Interest Deduction Per Return $278 $910 $1,674 $2,462 Percentage of Returns Claiming Mortgage Interest Deduction 4.0% 13.1% 24.2% 35.2% To claim the mortgage interest deduction, taxpayers must itemize when filing federal tax returns, rather than taking the standard deduction --- high-income taxpayers receive a much larger tax benefit from tax deductions than low-income taxpayers receive. $50,000-$74,999 $75,000-$99,999 $100,000-199,999 $200,000 and over 21.7% 18.2% 24.4% 11.2% 13.3% 7.3% 6.8% 1.9% $4,068 $6,210 $8,928 $14,374 50.9% 69.0% 78.9% 75.7% Low-income taxpayers tend not to own homes, especially those who are younger and live in urban areas. Factors Affecting the Distribution Con t High-income earners tend to have more valuable homes --- the greater the home value, the greater the interest payment on the associated mortgage. Speculators in real estate markets-those looking to hold a specific piece of real estate for a small period of time-tend to both earn high incomes and prefer interest-only mortgage. Increase in Popularity Interest Deduction The United States has an enviably high rate of home ownership and a highly developed infrastructure secondary markets in mortgage-backed securities, online mortgage companies, etc. that supports the construction and purchase of homes. Interest only Mortgages With the deduction, the government is effectively subsidizing your monthly payment. But you're not building any equity, you're just paying rent. It's hard to say how an interest-only loan encourages home "ownership." 2
Elimination What if eliminated? There have been proposals to eliminate the tax deduction on interest payments. Elimination would increase the chance of a decline in housing prices and less on an incentive to own a home. Having no deduction or tax credit would most likely have a negative effect on U.S. economy. Phased out? So, what would happen if the home-mortgage deduction were slowly phased out? For the sectors of the housing market where homeowners tend not to itemize deductions, the impact would probably be minimal. At the higher end, housing prices might be expected to adjust, but not to crash. Consider a home buyer in the 25 percent tax bracket with an 8 percent mortgage. Thanks to the interest deduction, he effectively pays 6 percent on the mortgage. Losing the deduction would have the same effect on his personal finances and mentality as a rise in mortgage rates from 6 percent to 8 percent would. A bummer? Certainly. But such moves have happened frequently without causing crises. The real harm would come to the home-building industry. Source: http://www.slate.com/id/2116731/ Policy Proposals Tax Reform Suggestions President Bush expected to propose a downgrade to the mortgage tax break. Nine member panel will likely propose a two part change in current policy Policy Proposals Tax Credit Converting the mortgage interest deduction to a tax credit equal to 15 percent of the interest paid on loans up to the mortgage interest cap. Mortgage Interest Cap Currently cap is $1 million Panel s proposal in between $172,000 for lower priced markets to $312,000 for higher housing markets http://money.cnn.com/2005/10/25/pf/taxes/homededuction_proposal/index.htm Who would Benefit? The higher your mortgage loan and the higher your tax bracket, the more likely it is that you'll see less of a tax break than you would under the current system. Take a new homeowner who pays $18,000 a year in interest on a $300,000 loan and itemizes his deductions on his federal return. Under the current system, if he were in the 25 percent tax bracket, he'd reduce his taxable income by $18,000, for tax savings of $4,500 (18,000 x 0.25). Under the panel's proposal, he'd only save $2,700 (18,000 x 0.15). That assumes the $300,000 loan doesn't exceed the mortgage-interest cap. But if he were in the 15 percent tax bracket, he'd see no difference under either scenario. Who would Benefit? And by transitioning to a credit, far more homeowners would get to take a tax break on their mortgage. It also may be the case for some homeowners that if they no longer can deduct their mortgage they may opt to stop itemizing altogether, instead taking the standard deduction plus the mortgage credit, if that would be allowed. In that case, conceivably they might enjoy tax savings equal to or greater than they would see under the current system. 3
Who Doesn t Benefit? The number of homeowners who take the mortgageinterest deduction is far smaller than the total number of homeowners who file tax returns. Those who don't itemize take the standard deduction, which they could take even if they didn't own a home. In 2002, of the 130 million federal tax returns filed, only 46 million were itemized. Of those, 37 million taxpayers claimed the mortgage-interest deduction. Who Doesn t Benefit? Among those who do itemize mortgage interest deductions on primary mortgages in a given year, only between 3 percent and 9 percent have mortgages over $300,000, said David Brunori, vice president of Tax Analysts. Those taking the larger loans tend to be in the highpriced, high-income markets on the East and West Coasts. So those are the taxpayers who may see the biggest hit to their tax savings if the rules change. If there will be tax reform, it's possible that what you lose in tax savings on your home you may make up for in new tax breaks elsewhere. Will such a change push down housing prices? In determining how much house they can afford, home buyers do price in the deduction that they've come to expect, said Keith Gumbinger, vice president of HSH Associates. So a change that would make the tax break less favorable to those in higher tax brackets and in higher priced markets could put downward pressure on home prices. The tax reform of 1986 ended certain tax breaks for those buying multi-family dwellings. Prices for rental buildings dropped for a period as a result. But, noted Nicolas Retsinas, director of the Joint Center for Housing Studies at Harvard, that was an instance where a tax break was eliminated, not just modified as would be the case with a new mortgage tax break. So What? The move to a mortgage tax credit could satisfy a number of objectives: It would more evenly distribute the tax break among taxpaying homeowners. It potentially would foster greater economic growth by making other types of capital investments as attractive tax-wise as housing. The panel's final report will be the starting point in the debate over tax reform among those in the White House, the Treasury and Congress. But lawmakers are free to discard or amend any proposal put forth. Translation: A whole lot of nothing or a whole different something -- may result. So What? The real reason we shouldn't bet the house on eliminating or reducing the mortgage deduction is the home-building, home-selling, and homebuying industries, which claim to speak for homeowners, would bitterly oppose such a move. And so it's no surprise that earlier this year, when President Bush penned instructions to the advisory panel on tax reform, he told them to "recognize the importance of homeownership." of the proposal Suppose we want to evaluate Tax Credit proposal. Things that need to be evaluated: Redistribution effects of benefits (towards the lower income end) Impact on housing prices Classical experimental design: Randomly assign 25 states in the experimental group, and the other 25 in the control group, pretest the states of these two groups to make sure they are similar. The experimental group will get the Tax Credit program. The control group won t. 4
6 0 7 0 8 0 9 0 1 00 1 10 1 20 1 30 1 40 1 50 1 60 1 70 1 80 1 90 2 00 2 10 2 20 2 30 of The Proposal after a certain period of time, measure the distribution of income in the experimental group and the control group. after a certain period of time( maybe a year), measure housing prices of these two groups. If the experimental group shows more even benefits distribution by income compared to the control group, then the first objective is achieved. If housing prices go down, then a decision needs to be made as to what level is acceptable for the benefits obtained. Mortgage interest tax deduction raises housing prices by allowing people to offset the amount they pay in interest knowing they will get it back at the end of the year. This allows them to buy more expensive houses pushing prices higher. The average home price in Salt lake city is 184,000 and the approximate amount of interest you pay annually is 11,700 dollars. Because of the standard tax deduction of 10,300 for married couples barely affects your tax return. For example a married couple that pays 15,000 dollars of interest on their home they would only have a tax benefit of 4,700 dollars. If you have a married couple that pays 1,000,000 dollars in interest annually on their properties they would be able to deduct 987,300 dollars. So, the more you borrow, and the higher your tax bracket, the more valuable the deduction becomes. In order to take advantage of the mortgage interest deduction you have to have paid more money in interest than the standard deduction. Standard deduction for a single person is 5,150. Standard deduction for a married couple is 10,300 The following is a graph that shows prices of homes and the estimate amount of interest you will annually. Amount paid in interest 16000 14000 12000 10000 8000 6000 4000 2000 0 Amount Owed in Thousands Tax deduction is very Unprogressive One of the biggest obstacles to homeownership is the inability to come up with a down payment. The deduction doesn't help you there. There are programs that were made to help with this but the normal allowance is only about 5,000 dollars. This policy does not benefit people that purchase homes under 160,000. The tax subsidy program is a benefit for the rich and is a barrier to the poor. Raises house prices Allow rich very large tax deductions 5
Section 8 Section 8 tenant based vouchers allow very low income families to rent safe decent and affordable privately-owned rental housing. To qualify for the program you have to be at 50% of the areas median income. 75% of the new vouchers must go to families that are below 30% of the areas median income. Section 8 cont. Now what that means in numbers is if the average 4 person family in Utah makes 42,000.00 you have to make less than 21,000.00 dollars a year annual income to even be able to apply for the program. Also you need to remember that 75% of the people on the program have to be below 30% of the median. Which would put your annual income at less than 12,600.00 In Utah as of 2004 there were 5,525 households that were taking advantage of the section 8 housing benefits. If you qualify for the program you can expect that the government will pay the difference after you pay 30% of your net income, 10% of your gross income or the minimum rent (HUD will determine a minimum payment that you would have to make between 0 50 dollars a month. The state will pay land lords 90-110% of the fair market rental value for the home or apartment that you are renting. Section 8 cont. Using your section 8 vouchers can be difficult for the following reasons. Difficult to find housing Landlords don t accept voucher Difficult to find the time to look for apartments Difficult to find transportation to find housing out of your current area One of the problems that this causes is the grouping of very poor people in a very small area making the problem even worse Conclusion Government gives benefits to home owners in the way of tax deductions Mortgage tax deduction tend to benefit rich. You can deduct 1,000,000 dollars annually Tax deductions allow people to purchase more expensive homes because they get it back at the end of the year. Married people only benefit after paying 10,300 dollar in interest and single people after 5,150. Section 8 housing Only help very low income families lower than 50% of the median income. It is difficult for people to use the vouchers because of landlords and difficulty in finding an apartment 6