Mortgage Deduction: Its Days Numbered?



The almost overwhelming size of the nation's debt -- $1.3 trillion for 2010 -- is influencing policy-makers from from both sides of the political aisle. Come Dec. 1, when a bipartisan presidential deficit-reduction commission releases a report on how we can fix this deficit, we could all be in for the surprise of our lives. Federal tax incentives for homeownership, they likely will say, need to be throttled back.

First target: the almighty mortgage interest deduction.
In 2010, the mortgage interest deduction added $100 billion to the deficit, for a total of more than $400 billion during the last five years. Even the most ardent supporters of homeownership, like San Antonio native Henry G. Cisneros, secretary of Housing and Urban Development in the Clinton administration, is bullish on getting the real estate and housing industries to "contribute their fair share." He should know: Cisneros is now chairman of CityView, an urban real estate investment company that develops a variety of urban projects: single-family, multifamily, warehouse conversions and mixed-use.

The former CEO of Dallas-based Trammell Crow Residential, J. Ronald Terwilliger, chimed in that a "phased-in reduction" of tax incentives over a period of years might be prudent, so as to not worsen an already ailing housing market.

Since the end of World War II, federal policies have been engineered to encourage and underwrite homeownership, because it was thought to be so very
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conducive to a stable, thriving workforce. Get a job, get married, get a home and a mortgage.

No politician dared mess with the sacred cow of mortgage interest deductions, capital gains exclusions, and property tax write-offs -- even if they cost the government billions in tax revenue. Why? Because messing with the concept of homeownership seems almost, well, un-American: everyone ought to have one.

Been there, done that.

The topic came up at the opening session of the Urban Land Institute's fall meeting Oct. 14. Five panelists, both Democrats and Republicans, said that while "continuing tax system support for housing is important, the current mix of tax incentives is costly and imbalanced -- favoring homeownership disproportionately over rental housing alternatives."

These theories will be delivered to President Obama's desk in about six weeks by the 18-member National Commission on Fiscal Responsibility and Reform, co-chaired by a Republican, former Sen. Alan Simpson, and former Clinton White House chief of staff Erskine Bowles. Notes from the commission have not been leaked, but housing analysts say it's just inevitable that the commission will propose cutbacks to tax subsidies for real estate.
Lawrence Yun, chief economist for the National Association of Realtors, projects that eliminating the mortgage-interest deduction would cause home values to drop 15 percent. The effect of a partial deduction would depend on many variables, he says, but any change would hurt the market as it yet struggles to recover. Currently, mortgage interest is tax-deductible to a $1.1 million loan amount. Experts say that threshold could be lowered significantly without diminishing the financial lure of homeownership for most consumers.

James Gaines, real estate economist at Texas A&M's Real Estate Center, says the main impact would be psychological – the switch from viewing homeownership as offering a tax benefit to one that it offers no (or substantially less) benefit.

"Then, again, depending on the size of the reduced benefit, it will increase the after-tax cost of housing, making ownership less attractive and causing rents to appear to be more attractive," says Gaines.

Keep in mind that one of the major advantages of the tax benefit has been to make the after-tax cost of owning considerably more attractive than renting. If this comparative advantage is reduced or lost, says Gaines, more people will consider renting to be just as economically advantageous as owning a home.

Gaines also thinks politicians will have a very hard fight with the NAR on this.

"Right or wrong, so many of the real estate agents think the tax incentives are absolutely essential for the market," he says.

While that may or may not be true, he says, what they fail to realize is that in the coming decade(s), the market is probably in for some very fundamental, secular changes, whether or not the tax incentives change.

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