For those who need a quick refresher, the MID can be traced all the way back to the original enactment of the Federal Tax Code in 1913. It also survived massive Tax Code changes back in 1986. In a nutshell, the MID allows homeowners to deduct the interest paid on a mortgage, line of credit, or home equity loan for a primary residence. The same is true even for a second home, (if the homeowner uses it at least 14 days a year, or 10% of the time it’s rented out), as long as that mortgage money is used to buy, build or improve the home—even while it is under construction for up to 24 months. That goes for aggregate loans all the way up to $1 million, equity loans up to $100,000.00, and late or prepayment penalties can also be deducted. The whole point of the MID is to encourage Americans to own their own home, and there’s sound economic reasoning behind that, since two thirds of America’s middle class wealth historically comes from home equity. And here’s a new twist—for homeowners who needed help these past few years from their State Housing Finance Authority, Hardest Hit Fund, or Emergency Homeowner Loan Program: payments made on those loans may be deductible too.
The reasons we keep hearing about potentially reforming MID have more to do with the current financial condition of the country than the merits of the MID itself. For example, back in the day of the Congressional “Super Committee,” Alan Simpson and Erskine Bowles suggested reducing the MID cap from $1 million to $500,000, and eliminating MID for second homes. The tough financial challenges Americans have faced require making tough choices, and across the country folks have had to tighten up spending and find new ways to supplement income. The problem is that when tough economic times pass, the compromises we make oftentimes stay with us. For example, you only need to pick up a newspaper to see how long lines in airports, courtesy of FAA sequester cutbacks, may become longer than a temporary inconvenience. On the other hand, approving gambling, or legalizing marijuana based solely on the rationale that we need the tax dollars, are the type of choices I'm talking about. Discussions to scale back or eliminate homeowner tax policies falls into this latter bucket, and have more potential to hurt homeowners than help them.
There are sound economic reasons why homeownership has always been a cornerstone of the American Dream. Dollar for dollar, you can certainly make more money investing elsewhere—if you have the time, discipline and sophistication to do so—but most Americans don’t. So homeownership is, in essence, a forced savings plan. Without it I’m not sure how average Americans can accumulate enough wealth to pay for their kids’ college or retire, because if they can’t, as taxpayers, we’ll all wind up picking up those bills. Important points to keep in mind are that 75% of middle class wealth comes from home equity…and 70% of GDP depends on those folks spending. 2007 was the first year ever that banks had more home equity than homeowners! American companies can’t make and sell stuff unless everybody can afford to buy it. For the same reasons, the stock we own in these companies and even our own home values depend on everybody doing well. And so, as we saw in 2006 when I wrote Foreclosure Nation, the problems that subprime borrowers had when paying their home loans back quickly spread to all of our homes, retirement savings, jobs, and ability to borrow, resulting in government bailouts with our tax dollars.
Critics cite the fact that the MID benefits homeowners with bigger mortgages the most, theoretically richer folks, which potentially encourages borrowing. Certainly no tax policy is perfect, and the problem is that many of the folks who also benefit from MID earn under $100K a year. And new homeowners—typically younger folks just getting started—tend to benefit more since that’s when people tend to have their largest mortgage, and pay the most interest. These homeowners are among the folks already hardest hit as it is. Communities with a large share of second homes—and over a third of U.S. communities are estimated to have at least 10% of their real estate as second homes, including many of the harder hit geographic regions—would obviously be even harder hit still, if second homes were eliminated from MID. One might expect to see the second home market soften in terms of demand and values. The effects of lowering the MID cap would be felt more acutely in areas where homes and mortgages often exceed that $500,000 cap. For the estimated 6 million homeowners currently in default on their mortgage loans and 10 million still underwater, losing that further MID financial incentive could easily be enough to make them simply walk away, and average families paying more money in taxes translates to consumers—who together comprise 70% of GDP—with less money in their pockets to spend. Multiply that times entire communities, and the potential impact of tinkering with the MID on our still fragile economy is not insignificant.
In December 2010, the President's Commission on Fiscal Responsibility and Reform released several proposals which would repeal the MID in favor of lower tax rates, reduce the MID $1 million cap to $500,000, eliminate the MID for second homes, and convert the MID to a 12% tax credit. As part of its 2011 and 2012 budgets, the Administration proposed limiting the MID for wealthier homeowners by essentially converting the MID to a 28% tax credit for homeowners in the 33% and 35% tax brackets. Homeowners earning less than $250,000 would, for the most part, not be directly affected. In his 2014 budget, President Obama is again is calling for a cap on the MID by limiting the value to 28% for homeowners in the 33%, 35%, and 39.6% tax brackets, a change some estimate would raise $318 billion over the next 10 years.
We’ve already seen fiscally driven changes in housing related tax policy. Until a few months ago, everybody paid 15% capital gains tax on the sale of a home, as long as they lived in the home as a primary residence for at least two of the past five years. But as part of the Fiscal Cliff deal, folks who earn $400K, ($450K for couples) now pay 20% instead. And there’s been discussion about raising the rate to 20% for folks earning over $200K ($250K for couples) as well. Folks who pay mortgage insurance on the primary or second home loan, and earn under $100K a year, used to be able to deduct those payments from their taxes, but already that benefit will stop at the end of this year. And we formerly were able to avoid paying taxes on money we spent for certain types of energy efficient home improvements, but 2013 is the last year that tax benefit will be available for homeowners as well. Short sales, by definition, require the mortgage holder to take a loss by forgiving some of the borrower's mortgage debt. Until 2007, when Congress passed the Mortgage Debt Forgiveness Relief Act, the tax code treated such forgiven debt as taxable income to the borrower. Fortunately, the President’s recent budget proposal would extend the Mortgage Debt Forgiveness Relief Act, now set to expire at the end of this year, through 2015.
It remains to be seen how tax policies that support and encourage housing—many of which have been around longer than we have—such as the MID, the ability to write off real estate taxes, mortgage insurance, and certain closing costs and capital gains, will continue to be supported in Washington. And if they are not, the ripple effect of a policy shift of this nature could have disastrous consequences on American attitudes about homeownership, personal wealth, and ultimately the American Dream itself. We all manage to find ways to balance our household budgets that are consistent with our values, attitudes, and the standards we hold ourselves to. Hopefully, Congress will somehow find a way to do the same.