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Saturday, January 29, 2011

Tax Benefits for Home Ownership

There are many tax breaks for owning a home (for a nice summary of these - see this page). In addition, if the owner uses the principal residence for at least two years in the five years prior to sale, $500,000 of any gain can be excluded from income (not taxed) if the owners are married ($250,000 gain exclusion if single). And, there was an $8,000 first-time homebuyer credit which has now expired. There is also a special temporary rule to exclude income from relief of any debt used to acquire a principal residence. There are a lot of tax breaks related to owning a home!

There seems to be more talk today, than I've heard before about reducing these benefits. I find that in talking about the tax rules related to home ownership, many people who are not tax practitioners are surprised to find out that the law allows for deduction of mortgage interest and property taxes on not only your principal residence, but also a second home, such as a vacation home. I think they are surprised because they think the home-related tax deductions are there to help and encourage people to buy a home. But, why would the government want to help you to own a second home? Some are also surprised that the mortgage deductions are so large - you can deduct interest on up to $1 million of debt used to acquire or improve a principal or second residence and up to $100,000 of home equity debt where the debt proceeds were used for any purpose (other than buying tax-exempt bonds). Even in California where homes are expensive, the median home price has always been under $500,000.

In terms of "tax expenditures" the mortgage interest deduction is one of the largest in the individual income tax system. In its report of tax expenditures for 2010-14, the Joint Committee on Taxation lists the mortgage interest deduction as a "cost" of about $95 billion per year (revenues not collected due to the deduction).

There has been much written about this tax expenditure and I won't repeat it here, but would suggest:
  • Center for American Progress - they are looking at one tax expenditure per week. For the week of January 24, 2011, it was the mortgage interest deduction - here. This is part of their "Doing What Works" project.
  • My 5/29/10 post which also refers to a Forbes article on tax expenditures.
  • Information from the final report of President Bush's Tax Reform Advisory Panel - pages 70 - 75, which provides a rationale for reducing the current high deduction amounts.
Should the deductions and exclusions for home ownership be eliminated? I don't think so in that one principles of good tax policy is economic growth and efficiency. Home ownership does provide many benefits to the economy and governments. Do the tax law have to offer tax breaks beyond the "norm"? No. This is quite costly and can even drive up home prices. The reports on the generous mortgage interest deduction find that they primarily benefit higher income individuals who can both afford to have a large mortgage and are in a higher tax rate so get a larger deduction. Also, why two homes rather than just one? Phasing out the overly generous/unwarranted tax deductions can provide funds to lower the deficit and perhaps even individual tax rates.

What do you think?

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