Threat of Mortgage Interest Deduction Loss

By Kevin Chiu

The National Commission on Fiscal Responsibility and Reform has stirred the proverbial hornets nest with its proposal to limit the homeowners’ federal mortgage interest deduction. But in real terms limiting or elimination of mortgage interest from federal taxes has little chance of happening. It’s a no-brainer.

The commission, created by President Barack Obama, is an effort to come up with a plan to help heal the U.S. economy. The commission spent nearly nine months delving into just about every conceivable part of the economy to come up with its plan as a starting point for discussion.

tax deduction

The housing option would exclude tax payers from deducting interest payments from second homes, lines of home equity and on mortgages over $500,000. The proposal was immediately criticized by the real estate and mortgage industries, including the chairman of the Mortgage Bankers Association.

“Given the fragile state of the nation’s housing market, now is not the time to be scaling back incentives for homeownership,” said Chairman Michael Berman. “The mortgage interest deduction is one of the pillars of our national housing policy, and limiting its use will have negative repercussions for consumers and home values up and down the housing chain.”

A reduction or exclusion of home mortgage interest would easily have a major impact on home prices, already deflated from the real estate collapse. But it may be important to understand that the deduction is not the result of a policy ever designed to encourage home ownership. The first federal tax in the U.S. was approved by Congress in 1894 and later revoked by the U.S. Supreme Court. It’s rejection by the court led to the Sixteenth Amendment that gave Congress the power to collect taxes “on incomes, from whatever source derived.”

To offset taxes and in an effort to keep harmony among the masses at the time, any interest paid became deductible. Interest was considered business expenses with a huge percentage of people renting during the era. The cost of paying interest on real estate was a daily cost of doing business.

However, through the years and with some political prodding from special interests like the National Association of Realtors and new homebuilders the deduction became a permanent part of the IRS income tax code. Later, insurance costs for property were added as a deduction and the practice became a standard part of the American dream of homeownership, which would cause a massive economic impact of disastrous proportions if eliminated. Imagine how many more Americans would walk-away from underwater mortgages then.

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