Impact of Eliminating Mortgage Interest

How Would Eliminating Mortgage Interest Deduction Impact Military Families?

by Karina Gafford

Tax time has come yet again, and this year military families should expect to see quite a few changes when it comes time to meet with tax advisors. Since it is always a good idea to look for the positive in any prospectively negative situation, some good news exists: The Basic Housing Allowance for military remains tax free, and in no way impedes the tax burden of military families. Other items, such as the teacher’s credit, a $250 tax credit that helps to off-set the cost burden of teachers who purchase resources for their classrooms, no longer exists. The removal of this deduction will definitely put a damper on the tax filings of the many military spouses and retired veterans who now serve as teachers. Despite its removal, this credit did not receive considerable media uproar.
 
Instead, the media has focused much of its angst on sensationalist tax deductions presented by congressmen and women this year for possible elimination, including the property mortgage insurance deduction and the mortgage interest deduction. The former, PMI, now has bi-partisan support for its extension the under candidly titled Senate bill, "A bill to permanently extend the private mortgage insurance tax deduction," (S.688). As of January 2014, the bill remained in the Committee for Finance Reform. This bill, or at least the idea behind the bill, holds considerable public support; the latter bill discussed, the mortgage interest deduction, meanwhile remains on the proverbial chopping block. The deduction is safe for this tax season, but recent research shows that controversy surrounds the deduction as it currently stands, suggesting that it may be ripe for reform, if not elimination.
 
What is Mortgage Interest Deduction (and why should I care)?
Popular among the middle to high middle income class, the mortgage interest deduction offers families a tax reprieve. According to a recent study from the Reason Foundation, US taxpayers have technically had the opportunity to deduct mortgage interest since 1913, though the deduction in its current form emerged in the World War II era. 
 
Though commonly understood as a benefit of homeownership, the mortgage interest deduction neither benefits all homeowners nor even applies to all homeowners. Most families today believe that mortgage interest deduction is a good thing, according to the Simpson-Bowles Commission of the Obama Administration, which looked at options for fiscal responsibility and reform.   However, given that the US tax code is so convoluted that multiple industries exist simply to help unpack the complexities of the code and explain it to the rest of us, it stands as no wonder that few taxpayers can clearly explain both whether and how the code applies to their particular circumstances in that particular tax year. If you are not entirely sure how this code applies to your situation, make sure to check for tax advisors in MBO’s Business Directory to find someone who can discuss your particularities with you! 
 
With the rampant lack of understanding of the applicability of mortgage interest deduction, an ethos has emerged that proclaims that mortgage interest deduction encourages home ownership. Though whether this correlation is true remains in dispute. If, let us imagine, a deduction in the mortgage interest does not affect the tax bill of most military families, then perhaps its elimination or reform may bring forth the possibility of tax benefits that would affect more of our families. If, as the current ethos stands, mortgage interest deduction does foster homeownership, then its elimination may detrimentally impact the ability of military families to not only resell their current homes, but also afford to buy a home at their next duty station.
 
Andrew Poulos, a columnist for the National Society for Accountants and Host of the Savvy Money Show, is an accountant who often works with military families to help them manage the complicated finances that result from regular moves across the US. Poulos firmly insists that eliminating the deduction will serve as a deterrence for homeownership, causing people to reconsider the benefits of renting when homeownership offers no tax incentives. Poulos suggests that the elimination of the deduction will have a significant impact on the choice military families may make on whether to rent or buy. For one, he explained to MBO, military families regularly purchase homes in which they cannot remain living in as a result of a PCS. This means that not only will they not receive a tax benefit on their primary residence, but also if the housing market deteriorates as a result of less market demand from less tax benefits, then these families will be stuck with these homes. This will leave many military families as reluctant landlords, stymied by the headaches of maintaining investment rentals across the country without receiving any tax savings. Without the tax deduction, Poulos suggests, the market rental amount may not cover the cost burden of the property, as BAH is not designed to cover the cost of a mortgage and interest, so without tax deductions, the property may not be as affordable as it seemed. This cost burden may leave military families who are already vulnerable to financial distress from a regular lack of a second income as a result of a PCS in a bad situation. Renting, Poulos therefore suggests, may present a better option for military families. 
 
Looking at the Numbers   
To better understand what part of the population are recipients of the benefits of the mortgage interest deduction, let us take a quick look at the numbers. Between 1994 and 2013, the mortgage interest deduction has amounted to somewhere between $40 million and $85 million. Despite a generally upward trajectory of savings for taxpayers overall, the US Census Bureau shows a relatively stable homeownership trend, reflecting very little change overall in the percentage of homeownership throughout these years. This suggests that the deduction may have minimal, if any, impact on a family’s decision to purchase a home.   
 
In 2012, only about 22-percent of the total number of taxpayers claimed the mortgage interest deduction. Families with incomes in excess of $200,000 received approximately 25-percent of the total tax benefit amount of $70 billion from that same year; whereas, data from the Joint Committee on Taxation showed that homeowners with incomes below $50,000 received about 3-percent of the benefits of the deduction. Almost 77-percent of families in the former income bracket claimed the tax deduction that year, but only about 22-percent of families in the latter income bracket could apply for the deduction, showing that a disproportionate amount of the tax benefit went to a small portion of the population. 
 
Based on these numbers, most military families do not fit the profile of those who stand to benefit from the mortgage interest deduction. According to the 2012 Demographics Report on the Military published by the Office of the Deputy Assistant Secretary of Defense, over one-half of all Active Duty Officers are under the age of 30 while half of all enlisted personnel are under the age of 25. The average age of an Active Duty service member is 28.7. Of the total Active Duty force, enlisted personnel represent over 83-percent of the force, presenting a picture of an Active Duty military that is far too young to have the buying power and wealth bracket that would benefit from mortgage interest deduction. Unfortunately, the report did not cover the age range for the total military force, including retirees, so for the purpose of analyzing the effect on military families, we will use the average age of service members.
 
At an average age of 28.7, the typical service member—both officer and enlisted—has a base salary lower than $50,000. As the data from the JCT above shows, few families with incomes below $50,000 are eligible to claim the deduction, and those who do claim it save less than $650 per year, a negligible amount when compared to the painfully high mortgage interest statement that arrives in the mail each January. Most families below that income bracket simply do not have a need to itemize their deductions for expenses, so they cannot make the claim. The standard tax deduction for 2013, for example, was $12,200 for married couples filing jointly, or $6,100 for individual tax returns.
 
The Mortgage Interest Deduction Bill in Question for 2013.
Politicians are generally averse to taking a position against the deduction despite the discrepancies that exist in terms of who a) receives the lion’s portion of the tax benefit and b) the savings that the government could yield by either eliminating or reforming the tax code to provide a greater access to deductions across the board. In 2013, however, one Congressman did present a bill making such a suggestion. The bill has received both adulation and condemnation, showing that any change to this stalwart of the tax code is highly controversial, making either the prospective progress or termination of this bill an interesting case to watch over the next couple of years!
 
In March of 2013, Congressman Keith Ellison (D-MN) of the House Financial Services Committee introduced a bill that would ultimately eliminate the mortgage interest deduction. Ellison presented the bill, commonly referred to as the Common Sense Housing Investment Act of 2013, H.R. 1213, as a reform to the current mortgage interest deduction program. It would provide for a "phaseout of the tax deduction for mortgage interest between 2014 and 2018," with the intention of using the savings for programs such as those that would "increase the state housing credit ceiling for the low-income housing tax credit." The bill currently has 13 sponsors in the House of Representatives who span districts all across the nation from Florida to Washington, showing that it has wide-reaching support. At this time, however, the bill remains under review in the House Ways and Means Committee, but two additional sponsors have withdrawn their support of the bill.
 
What Does the Research Show?
Research foundations, such as the Pew Charitable Trust Foundation, show that the mortgage interest deduction unfairly benefits those with higher incomes, and in turn, reduces tax money that would otherwise be available for public housing programs. Public housing programs aim to provide housing at an affordable rate, which means that the occupant pays less than 30-percent of his budget for his housing expenses. Given the recent recession, affordable housing demand has grown while availability cannot keep up.
 
Steve Brown, the brand new President of the National Realtors Association, disagrees with the Pew’s Report. He explained that tax deductions such as mortgage interest "were put there to encourage ownership and affordability, and it’s very important that these issues stay in the tax code." In a recent interview, Brown explained that the NAR will not compromise on their position regarding the important of maintaining the mortgage interest deduction. He believes that even though it does provide financial support for the expensive homes of the wealthy, the deduction also encourages the purchase of second homes, as families can currently deduct a portion of the interest on second homes, too. These second homes, he explained, cost only $129,000, which is approximately half of the price of an average single family home in the US.   If mortgage tax deductions did not exist for these second homes, too, he argues, then small communities, such as the Lake Erie Shore, where such houses are located would suffer detrimentally.  
 
Other research institutes do agree with Brown’s position that the deduction is a vital part of the tax code. The Tax Foundation, a research organization that has been around since the Great Depression, suggested that, though legitimate concerns do exist for the reform of the deduction, the elimination of the deduction would cause disastrous results in the US economy to the tune of $254 billion in unspent revenue. An assumption in their figure holds that the deduction fulfills its social objective of encouraging homeownership, and without the deduction, homeownership would not present as attractive an option as it does currently. 
 
Conclusion
As research has shown, the claim that the deduction encourages homeownership remains a skeptical one, as it seems that a tax deduction does not encourage homeownership for those who would otherwise not buy. Evidence suggests that, though nice in theory, the mortgage interest deduction program in its current form may not offer the tax benefits to military families that, according to the Simpson-Bowles Commission, we believe it does offer. An elimination of the program may not see much impact for most military families, though a reform could stand to reduce the tax burden military families face each year. Regardless of whether the mortgage deduction currently impacts military families, any reform or elimination may require significantly more advance tax planning, Poulos warns. "If they don’t have enough taxes withheld," he explained, "[then] they could potentially be hit with a tax bill when they file their taxes." If you think you may need to speak with a tax advisor or real estate agent regarding your current property, make sure to check through MBO’s Business Directory to find someone with experience working