Home mortgage interest deduction

A home mortgage interest deduction allows taxpayers who own their homes to reduce their taxable income by the interest paid on the loan which is secured by their principal residence (or, sometimes, a second home). Most developed countries do not allow a deduction for interest on personal loans, so countries that allow a home mortgage interest deduction have created an exception to those rules. The Netherlands, Sweden, Switzerland, and the United States each allow the deduction. The standard justification for the deduction is that it encourages home ownership. Countries that tax imputed income on home ownership may allow the deduction under the theory that it is no longer a personal loan, but a loan for income-producing purposes. Standard criticisms are that it does not significantly impact home ownership, that it allows taxpayers to circumvent the general rule that interest on personal loans is not deductible, and that the deduction disproportionately favors high-income earners.

1 Policy arguments for and against the deduction
2 Status in developed countries
- 2.1 France
- 2.2 United States
3 See also
4 References

[edit] Policy arguments for and against the deduction

The standard justification for the deduction is that it incentivizes home ownership.^[1] A second justification applies to countries which tax imputed income on home ownership, such as Sweden, the Netherlands, and Switzerland: since home ownership generates imputed income under such a system, the interest on the home loan is no longer a personal expense, but an expense necessary to "earn" the imputed income, and therefore should be tax deductible. In fact, Sweden, the Netherlands, and Switzerland do allow a home mortgage interest deduction.

There are several standard criticisms of the deduction. Critics argue that:

the deduction does not have a significant impact on home ownership rates;^[1]
allowing the deduction for home equity loans taken out for personal consumption allows taxpayers with home equity to effectively circumvent the rule against the deductibility of interest on personal loans;^[1]
the deduction disproportionately favors high-income taxpayers.^[1]

[edit] Status in developed countries

[edit] France

France does not allow a home mortgage interest deduction. In 2007, newly-elected President Nicolas Sarkozy proposed creating the deduction as part of his legislative plan for sparking the French economy.^[2] In August 2007, the Constitutional Council, the highest court in France, struck down the mortgage interest deduction as unconstitutionally creating a tax advantage that goes far beyond its stated goal of encouraging non-homeowners to buy homes. The Court noted that the deduction would apply to people who already own homes.^[3]

[edit] United States

Under 26 U.S.C. § 163(h) of the Internal Revenue Code, the United States allows a home mortgage interest deduction, with several limitations. First, the taxpayer must elect to itemize deductions, and the total itemized deductions exceed the standard deduction (otherwise, itemization would not reduce tax). Second, the deduction is limited to interest on debts secured by a principal residence or a second home. Third, interest is only deductible on up to $1 million of debt used to acquire, construct, or substantially improve the residence, or on up to $100,000 of home equity dept regardless of the purpose or use of the loan.

Prior to the Tax Reform Act of 1986 (TRA86), the interest on all personal loans (including credit card debt) was deductible. TRA86 eliminated that broad deduction, but created the narrower home mortgage interest deduction under the theory that it would encourage home ownership.^[1] A New York Times article notes that Congress "certainly wasn't thinking of the interest deduction as a stepping-stone to middle-class homeownership, because the tax excluded the first $3,000 (or for married couples, $4,000) of income; less than 1 percent of the population earned more than that"; moreover, during that era, most people purchased homes with cash rather than taking out a mortgage. Rather, the reason for the deduction was that in a nation of small proprietors, it was more difficult to separate business and personal expenses, and so it was simpler to just allow deduction of all interest.^[4]

In the United States, there are additional tax incentives for home ownership. For example, taxpayers are allowed an exclusion of up to $250,000 ($500,000 for a married couple filing jointly) of capital gains on the sale of real property if the owner used it as primary residence for two of the five years before the date of sale. Furthermore, U.S. taxpayers are not taxed on imputed income derived from home ownership. This can be explained by comparing a person who owns a home and rents it out to strangers. The rents received are included in the taxpayer's income. If this taxpayer rents a place to live because he chooses not to live in the home he owns, the payments he makes is not deductible because it would be a personal expense. Simply by evicting the tenant and moving into the home he owns, this taxpayer avoids including the rent on his own from his gross income.

The National Association of Realtors strongly opposes eliminating the mortgage interest deduction, claiming, "Housing is the engine that drives the economy, and to even mention reducing the tax benefits of homeownership could endanger property values. Home prices, particularly in high cost areas, could decline 15 percent if recommendations to convert the mortgage interest deduction to a tax credit are implemented."^[5] While politically popular, economists are basically united in their opposition to it.^[6] The Tax Foundation has stated that few low- and middle-income taxpayers benefit,^[7] calling it subsidization of the real estate industry.^[8]