Monday, January 29, 2007

Home Mortgage Interest Deductions

Recent readers are not familiar with older posts. For instance:

gordo suggested;

"Here's a very easy fix - end the mortgage interest deduction and capital gains exemption. The whole sleazy industry goes away in a heartbeat. I'm a renter - I'm fine with that. Any home owners want to get on board?"

The HMID (Home Mortgage Interest Deduction) has been explained many times but here it is again.

The Home Mortgage Deduction is -not- a subsidy. The HMID serves to remove the difference between business and private property treatment. Were the HMID to be reduced for typical families it would only serve to push the rich into complex tax avoidance schemes involving shell businesses holding title and the rich merely occupying the residence.

As long as the home mortgage interest deduction is viewed as a subsidy and not as the extra tax anti-investment burden it truly is there can be no rational housing policy debate.

The implication behind all this is that there exists outside of stated and revealed preference data a "correct size" for a residence. I'm as unwilling to presume such an arbitrary number as I am to presume the correct number of children. Face it, the two differ only in degree not kind. This is the steep part of the slippery slope that started with CAFE standards and gas guzzler vehicle taxes. People don't even blink at those anymore to the point that no doubt some will respond with anger.

McMansions are indeed a burden on previously constructed neighborhoods and oftentimes municipalities but they are burdens directly attributable to several new urbanist preferred outcome distortions and not some emotional gut response to any perceived excess. Tax policy isn't the problem or solution. West Germany used to tax propety based on the number of rooms, this led to homes with no closets which were classified rooms. The same avoidance schemes are the only predictable outcome of trying to control housing form.

Housing is a hybrid of both a consumable product and an investment vehicle and thus defies absolutist claims of either characteristic. Any further attempt to seperate the two will also devolve into a game of tax avoidance. As much as the current no limits deduction is unfair it is also less unfair than any other possible alternative.

That's the HMID. The Capital Gains exemption is a different story. I suspect, that's suspect, that if it were truly about one's primary residence there would be no problem. The problem is the abuse of the intent. My solution is subtle.

The Cap Gains exemption applies to people who have occupied their home 2 of the last 5 years.
Should be:
The Cap Gains exemption applies to people who have occupied their home 2 of the last 5 years OF OWNERSHIP.


Hi...I'm Dolph DeRoos said...

Thanks Robert. Excellent post on the HMID. This is a good post and a welcome respite from Caseyland.

You and I agree completely on your suggestion on how Cap Gains SHOULD work. I wish it went farther to penalize flippers and speculators. It should reward ownership whether you own a multi unit building or an occupied residence. Allowing the likes of Casey to game the system for quick riches sucks (to use one of his choice words).

I would LOVE to close any loopholes that allow the Caseys of this world to write off losses from flipping. It should penalize for get rich quick types, but alas it will most likely never happen unless a serious crash happens.

Anonymous said...

I used to live in South Africa and homes were taxed on the numbers of toilets inside. Their economic & political policies left the majority of the population without access to even basic indoor plumbing so toilets were deemed a luxury good for tax purposes. Just something to think about folks...

Anony Mouse said...

Should be:
The Cap Gains exemption applies to people who have occupied their home 2 of the last 5 years OF OWNERSHIP.

Great Rob. So I'd be gettting out of cap gains when I sell to move into the nursing home.

bulksalty said...

Now that cap gains are generally considerably lower, what's wrong with treating a home like any other asset? 15% long term (>1 yr), short term at your marginal rate (<1 yr). As an added bonus, there might be some support for keeping capital gains rates low. I agree that the home mortgage interest deduction equalizes the tax burden between owning and renting (because it takes no talent to be a landlord your rent already is discounted for the tax savings on interest).

anon@1am said...


excellent post.

question: how much of a rent subsidy is the HMID? Don't most landlords set up LLCs at least to hold the properties (thus, getting to deduct the interest as a business expense anyhow).

Eliminating the HMID would make housing prices drop like a stone, and would have minimal effects on rent IMHO. so, it would be a win-win for renters.

gordo said...

When you buy a house you buy 3 things:

1. A place to live
2. A tax deduction
3. An investment

Sheeple have focused on numbers 2 and 3 and forgotten about number 1 therefore overestimating the value of numbers 2 and 3.

They also overestimate the value of number 2 in relationship to cash flow. Yes, as a renter I don't have a tax deduction, but I live in a nice place and a comparative mortgage plus other costs net of the tax deduction would cost me much more a month than the rent.

The lure of the tax deduction makes sheeple do stupid things.

Now for number 3 - is housing a good long-term investment? Personally, I don't think so, but smart people disagree with me. Studies show that the stock market over time has a better return - housing barely beats inflation.

If you want to drive the loan sharks, scam artists, Casey Serins etc. out of the housing market focusing just on the capital gains won't do it - sheeple think they really need that tax deduction. You have to minimize the value they perceive it provides.

Anonymous said...

As a landlord, I think I might be able to clear this up.

I rent out my property. I fill out Schedule E. Interest on a loan is treated as any expense would be -- the same as maintenance, advertising, etc.

So I take my gross rent, subtract my expenses, and I'm left with profit. That goes onto my 1040 form as ordinary income.

Now, I get to deduct the interest on the home I live in on Schedule A. I certainly don't deduct the interest on my rental properties there.

So the way I view it, the homeowner interest deduction is just that -- a deduction. The interest I pay on the mortgage for my rental is kind of like a business expense in that regard. I'd get that same expense even if I didn't own the home I live in.

So to sum up, you don't get the so-called "Home Mortgage Deduction" for homes you rent out, but it really amounts to the same thing in the end, I guess.

Adam said...

I think the key to 3 is what I'll call 3a Leverage! When you buy a home your investment is a 5:1 (traditionally) to 20 or more:1 levered investment. As long as the return on the home price is above the mortgage interest rate, the return on your investment will greatly exceed the return on almost any investment most people will have. I think long run homes return about 6%, so if your mortgage (after taxes) has a cost of 3.5% and you put 20% down, the return on your 20% will greatly exceed the 10% that the stock market is expected to return (in my example 16%). If you could some how borrow 80% and put it to work in an index fund, your return on investment would be much higher than this, but highly volatile (so you'd need more capital available to meet margin calls--interesting idea for the equity rich who have or can get a HELOC).
The two things that most people don't really understand are exponential curves and leverage. The savvy mind will note that the last two bubbles involved one or the other.

Hecatonchires said...

I don't think capital gains tax is a good idea - in general. Nor should income tax be levied on interest on savings.

I can see both sides of the mortgage interest deduction.

Eth Real said...

I come from a tax system where invevstment property mortgage interest is tax deductible and owner occupied is not. It creates a rather unusual situation where people will buy rental properties and remain renters themselves. I prefer the US system by a long shot.

segfault said...

Yes, the value of the HMID is overestimated by a lot of people. People hear the words “tax free” or “tax deduction” and their eyes just glaze over and they’re sold. In theory, it’s a bad investment, but, there is the idea that, in practice, home equity is a form of “forced savings plan,” even if the expenses involved are very high, a homeowner will eventually end up with some equity. Personally, I rent as well, but will probably buy after I finish grad school and have a steady job. And, mortgage interest deduction or not, I’ll probably make extra principal payments on the mortgage.

SadAboutBarbaro said...

Since hearing the news about Barbaro this AM, I’ve been pretty sad and uninterested in Casey Serin, housing, etc. He seemed so much more noble than any of our politicians, sports figures, etc. and his recovery was the only hopeful news in 2006.

Benoit said...

More public records snooping on Casey, INCLUDING HIS MOM'S E-MAIL ADDRESS. Read on!

OK, we all know Casey's dad is Aleksey. A public records search reveals that Casey's mom is named Anna... and she's the only "Anna Serin" I could find in the United States. She turns 44 later this year.

A simple web search shows that she works for the Grant Joint Union High School District (GJUHSC) in Sacramento.

Her e-mail address is:

... and her work phone is:


The webpage where I got this information is here (it even has her office hours!!):

... anyone up for informing Ms. Serin what he oldest son is up to?? hehe.

- Benoit (Homey Da Clown's protege)

P.S. This message will be posted in the next Casey related update as well. ;-)

Wet Dry Sandpaper said...

M. Coté,

Up here just north of the Excited States, there is no HMID. There is also no complicated arbitrage going on trying to make home mortgage interest tax deductible - which is possible but cumbersome - or running some corporate scam - not possible at all because of tax mechanics.

The end result has not been a nation of frantic tax planners but rather a generally lower house price level relative to rents.

You know very well that current prices in the US are an absurd multiple of rents. If HMID were abolished, prices would fall to a slightly less absurd multiple.

Big deal.

P.S. Full capital gains exemptions on principal residences here, no minimum hold period required, although the taxman might wonder if you moved three times a year. It's never been a big problem.

Anonymous said...

The guy who recommened a toilet tax is spot on!

I would go one 1 step further and impose a 'toilet usage tax' since its not fair if you have 2 toilets, but only use one. (the unused guest toilet example).

This would spawn an entire industry of toilet meter manufacturers helping to encourage investment.

You would pay tax on a multiple of the weight and volume of your yearly waste divided by your NET after tax income. With a gradually increasing rate base on waste usages (to appropriately tax multiple family toilet users).

This is exactly the kind of complicated need-an-accountant-to-make-sense-of-it tax law we effing LOVE here in the states. It will even supposedly 'save water'.

The best part: It will have the always present unintented consquences of govt intervention. Possibly raw sewage in street eveywhere(done by tax cheaters!) and a large increase in water use by thier neighbors constantly hosing the tax cheating evidence down the street.

Similar to opposite unintended consqeunce of 1997 tax free primary residence sale = you save money selling tax free, but housing then quadruples due to this law in part so you are actually worse off if you sell and take the tax free money since you have buy back in at inflated price. Awsome. Just like welfare increases poverty and defense spending causes more wars.

Seriouly our tax laws are byzantine and insane. I have to think of tax consequence before i move,buy,sell ANTHING and the timing of such - then keep track of it in files for 5 years. Some freedom. Fuck you complicated tax code.

Anonymous said...

ok theres more...

then the huge unintened opposite consquences of the 'toilet wast tax law' causes a massive raw sewage problem and people scream for govt intervention so the FBI and IRS get involved in cracking down on tax cheaters. Need cameras EVERWHERE to catch people eliminating in the streets (thats taxable and must be done in toilet!)

So we hire more fbi and run radio spots to 'turn in ' offenders. Its just grows from here when we run out of room in prison for them.

Seriously this is just like the effing housing bubble! government has turned us into a bunch of tax code house obsessed maniacs. Pass tax breaks and laws then we kill ourselves to take advantage of it and turn in the 'cheates' and create industry to catch the cheaters, what the hell do we actually DO in this country? What should we be doing? It seems like we are fighting foreign wars to keep the business of flipping houses to each other 'safe'.
None of this actually contributes to the economy long term once you get excess housing supply.

rant over.

NoVa Sideliner said...

Regarding the tendency for buyers/owners to overrate the Home Mortgage Interest Deduction:

Despite what real estate agents tell you, in a lot of cases in low-income-tax states, your mortgage interest deduction GETS YOU NO TAX ADVANTAGE AT ALL! Sure, in the expensive NorthEast or CA regions, not a problem. But...

Unless you have enough in interest, property tax, and state income tax (and other deductions) to get above the standard deduction, you're better off with the standard deduction of $10,700 that a joint return will get anyway.

Not only is this often a concern in states with no (or very low) income and property tax, but it's also a concern if you're not making a lot of money (thus don't pay much state income tax) and buy a cheap house (paying less interest and lower property taxes).

Case in point Friend of mine some years back in Texas bought a house for (yes, only) $68k, proudly stating how much he'd save on his taxes. Real rough numbers:

$68,000*80% => $54,400 borrowed
$54,400*8.5% = $4,624 interest
Add property tax: $1,500 (guess)
Add income tax: $0

And you have $6,124 "deductible".

He thought he'd get about $1,500 back on fed income taxes, but he was actually better off with the standard deduction! He refused to believe me (nor read the tax rules) -- that is, until he did his W-4 and thought something was wrong, and then did his taxes a year later and cursed.

"But the realtor said..."

Bwaahahahahahaha! Another victim of the ignorance and spin. Sadly, there are lots of first time buyers like him whose ignorance is adding many thousands to the price they're willing to pay for a home.

Anonymous said...

"The Home Mortgage Deduction is -not- a subsidy"


It is a subsidy.

Just because businesses can write the equivalent off does not change that.

If you want parity, eliminate the relevant deductions for businesses.