December 30, 2016

Mortgage Interest Deduction: At Risk or Politically Untouchable?

With the incoming Trump administration and the Republican control of Congress, the country appears to be on the verge of tax reform, both for individuals and corporations. For individuals, tax reform is typically centered on marginal income tax rates, but effective income tax rates, which take into account deductions, exemptions and statutory adjustments, are more important and complex.

For example, in 2014, the average married couple with total income of $63,400 fell into the 15% marginal tax bracket, but after reducing income by $11,900 of exemptions, $6,400 of deductions and $1,000 of statutory adjustments, taxable income was $44,100 and the effective tax rate was 5%.

In 2014, mortgage interest was the second largest itemized deduction for all taxpayers, registering almost $290 billion, trailing only state and local taxes at $330 billion. At this point, the Trump administration and Republication House proposal both stipulate that the mortgage interest deduction would remain in place, but changes to the marginal tax rate or standard deduction can still alter the value of the deduction.

To put this into perspective, we first offer some facts about the mortgage interest deduction. In 2014, we estimate that there were approximately 120.4 million households. By definition, 44.7 million renter households do not have a mortgage. Of the remaining 75.8 million owner-occupied households, 25.4 million do not have any mortgage debt, or related interest to deduct. That leaves 50.4 million households that have mortgage interest to deduct; however, 17.6 million of them do not itemize their deductions, but rather elect for the standard deduction. As a result, the 32.8 million households that utilized the mortgage interest deduction represent just 27% of all households.

To the extent the standard deduction is raised as proposed under both the Trump and Republican tax plans, it would mean that the 35% of mortgage holders that do not claim the mortgage interest deduction would climb by a substantial amount – effectively devaluing the interest deduction.

Housing-related lobbying efforts will undoubtedly fight tax reform that directly or indirectly deemphasizes the mortgage interest deduction under the premise that doing so would undermine consumers’ desire to own their home. However, as a counter point, we find it telling that almost 60% of homeowners today receive no benefit from the mortgage interest deduction and another 20% make at least $100,000 a year, suggesting that a shift in behavior would likely be modest. We are sure others will disagree, so let the debates begin!

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