Deduction of Interest on Home Mortgage on the Chopping Block?

[Bryan Hancock]

I have seen several articles claiming that the deductibility of interest for your primary residence is on the chopping block to close our budget gap.

Does anyone know what is happening with this? Who is pushing this change?

[Brian Levredge]

Originally posted by Vikram C.:
Bryan, I was using a simplified example to illustrate my main point. All owners of a property are going to have expenses associated with owning the property, such as capex, repairs, taxes, insurance, etc.

My point is that if you allow a landlord to deduct the mortgage interest (as a business or investment expense) but you do not allow a home-owner to deduct the mortgage interest, then you are actually discriminating against owner-occupied home-ownership. You are not creating a level playing field.

The underlying economics of this is that a landlord is going to pass on all his costs through the rent charged. If his costs are less than that of an owner-occupier, then renting will be cheaper than owning. Why would we want to discriminate against an owner who occupies his home versus one who rents it?

I have several issues with this. For starters, with few exceptions, renting is almost always cheaper than buying. There is a very good reason that the tax code is tilted in favor of landlords rather than home owners. Landlords provide a fundamental need that the govt has tried, and failed, to provide in the past. Recognizing this failure, they incentivize the private sector to fulfill this need. Whether or not you agree with that is an argument for a different thread.

On the whole, there are far fewer landlords than there are home owners, since landlords often own multiple properties. Frankly, there shouldn't be a level playing field between owning and renting either (not that I think you are implying that). Owning a home is a both a privilege and a great responsibility.

[Vikram C.]

Brian, you are right that I was not advocating a specific policy. I was merely trying to point out that the common perception of the mortgage interest deduction tilting the scales in favor of home-ownership is false. The deduction actually levels things between renting and owning. (To be perfectly honest, I, too, had held that incorrect view until I thought about this a bit more.)

I agree that renting is typically cheaper than owning from an initial cash-flow perspective. I guess landlords are willing to have a lower initial yield in return for the expectation of appreciation and rent increases. But that does not change the underlying economics of the tax deduction for mortgage interest.

[Bryan Hancock]

I agree that it causes things to converge from a strictly economic model Vikram. Things are alway nice and tidy in economics land where people are rational and set prices rationally.

However, renters fundamentally cannot afford spikes in expenses for the most part. They transfer these (roofs, foundation problems, etc.) costs to their landlords and thus rationally pay a premium for space because of this built-in smoothness of expenses. They also do not carry depreciation expenses and a variety of other tax-based advantages implicit to ownership, which further distort a direct comparison.

Fundamentally I still say you are comparing apples to oranges and that one should not juxtapose indirect rent pricing with direct home interest deductions. They are two different animals and carry two fundamentally different bundles of rights, expenses, etc.

[Vikram C.]

Not really, Bryan. If people are going to argue that the mortgage interest deduction favors home-ownership versus renting when that is in fact untrue, it needs to be pointed out.

The idea about bundle of rights, etc. is not really relevant to this discussion because we are simply comparing the cost of living in a home in a buy vs rent decision.

Finally, the issue of things being nice and tidy in economics land is not a useful way to discuss this because real estate markets exist in economics land and the idea of tax policy favoring one type of ownership versus another is an economics argument, albeit one that is not well-considered.

No apples and oranges here, Bryan. They are apples to apples. If you think about it, when people say that the mortgage interest deduction favors ownership to renting, they are already comparing the two. I am merely pointing out that their conclusions are incorrect.

[Bryan Hancock]

Okay fine...I guess I am pointing out that comparing the two is a lot more difficult than simply comparing space in one arrangement to space in the other arrangement. That may or may not relate to the original point that sparked the discussion.

Fundamentally, renting and owning are two different beasts and a cozy economic model cannot be easily constructed to carve out a tidy comparison between home mortgage interest deduction and expensing with managed space.

Paper losses in one instance versus the other, participation in appreciation, amortization of debt, "pride of ownership," flexibility to move when one wants to, etc. etc. all distort an apples-to-apples comparison based simply on the sort of analysis you are proposing.

Like I said...I agree that deductibility of home interest causes things to converge with a simplistic analysis. I disagree that the analysis is as easy as is being presented though. Even if we could agree on a model for many of the profit centers intangible factors like pride of ownership and such would distort the model.

[Vikram C.]

The analysis is not "simplistic." It is "simplified" for the purpose of clarity.

You can't have it both ways, Bryan. You cannot state that the mortgage interest deduction favors home ownership vs renting and then also state that we cannot analyze it because renting and owning are apples and oranges.

[Bryan Hancock]

I never said it favors homeownership vs. renting...did I? Perhaps someone else did and you thought that I agreed with them somehow.

They are two different beasts. I do agree that the deduction causes a simple space versus space economic comparison to converge though.

I am all for abolishing it along with paper deductions and about 90% of our screwed up tax code. Our country is seriously screwed up when we pay tax professionals more than engineers and scientists.

I am also for getting the government out of our lives as much as possible instead of having them steer our behavior via tax policy and social engineering policies.

[Vikram C.]

Maybe I misunderstood your position then. I thought you were supporting the argument that the interest deduction creates a bias in favor of home ownership, which it does not.

I do agree with your overall philosophy though. The ideal income tax is no income tax. And if you are going to have it, make it as simple and as flat as possible.

The only reason that I am not in favor of abolishing the deduction for mortgage interest is because it will further skew the tax bias against home ownership. As you know, landlords have a variety of tax benefits from their ownership of a property that owner-occupiers don't. I would not want to take away a further benefit from owner-occupiers and make the situation even more unfair. Otherwise, we may find ourselves in the perverse situation where it is much more profitable for two neighbors to own each other's homes and rent them out than to own their own homes.

I think the problem with inflated asset prices has been caused by a variety of factors such as (a) government guarantees of mortgages, (b) short-term executive compensation arrangements, (c) lack of shareholder rights, (d) non-recourse home loans and (e) the stupidity and greed of home buyers. I would not want to mess with the tax treatment of home ownership as a way to prevent a future bubble because it was never a cause in the first place.

In fact, I would argue that our mutual distrust of government interference in markets would cause us to want the government to give home owners all the normal deductions that investors get. Why should the government favor one form of ownership and structure over another? All investments in assets, including the ownership of one's own home OR a rental property, should get the exact same tax treatment. The government has no business micro-managing these things through disparate tax treatment.

[Account Closed]

Originally posted by Bryan Hancock:
I never said it favors homeownership vs. renting...did I? Perhaps someone else did and you thought that I agreed with them somehow.

They are two different beasts. I do agree that the deduction causes a simple space versus space economic comparison to converge though.

I am all for abolishing it along with paper deductions and about 90% of our screwed up tax code. Our country is seriously screwed up when we pay tax professionals more than engineers and scientists.

I am also for getting the government out of our lives as much as possible instead of having them steer our behavior via tax policy and social engineering policies.

Bryan, I would love to see the current system replaced with a more fair flat tax, but eliminating large pieces of the current system that will have a large effect on the middle class is not in the best interest of the economy, IMHO.

Tax policy has always favored certain special interests. Taking away a tax credit for those that currently own their homes is going to place greater burdens on the housing sector. We have already seen a lot of people walk away from under water homes. Further stressing a bad situation is only going to make it worse.

The mortgage interest deduction is a huge tax savings for many of the clients I work with. Home ownership usually means they can itemize. Without the home many people would not be able to itemize.

[Brian Levredge]

Originally posted by Vikram C.:

In fact, I would argue that our mutual distrust of government interference in markets would cause us to want the government to give home owners all the normal deductions that investors get. Why should the government favor one form of ownership and structure over another? All investments in assets, including the ownership of one's own home OR a rental property, should get the exact same tax treatment. The government has no business micro-managing these things through disparate tax treatment.

A large part of your argument seems to be based on viewing home ownership as an investment. This is not a view that I hold (I know there are others here with a similar view) since individual home ownership is not an investment, at least in my eyes. I had a real estate finance professor in college who laid out for us the true cost of ownership vs renting taking into account after tax benefits. His analysis showed that assuming you bought a house at 25 and never moved that it would be cheaper to rent until you were 107 years old.

Landlords are running a business. Businesses provide jobs and thus create additional tax revenue. That is why landlords get much better tax treatment than individual home owners. Should that not be the case for business owners? I agree in general with your sentiments regarding disparate tax treatment, but I do see a clear differentiation between business owners and home owners.

[Vikram C.]

Brian, you make a good point and I think the difference in our perspectives could be the result of how we view homes. I consider the acquisition of a large asset (such as a home) to be an investment. I agree with you that it may often be a poor investment but it is an investment none-the-less.

[Brian Levredge]

Vikram, yes a solid argument could be made that buying a house is an investment. I would posit that it is one that is often driven by emotion rather than metrics as RE investing tends to be. Certainly, you need to be able to qualify for a home loan but with programs like FHA, you can do so without much out of pocket expense. From that point, you have money constantly flowing out even after you've paid the mortgage off. Your only real return is the equity (which you've been paying down as well) from appreciation, which as we know is far from certain.

[Bryan Hancock]

Originally posted by Vikram C.:
Maybe I misunderstood your position then. I thought you were supporting the argument that the interest deduction creates a bias in favor of home ownership, which it does not.

I think it does create a bias in favor of homeownership. I also think there are a ton of other biases on both sides and that all need to be balanced in total and that the analysis is very complicated. I also agree with the others that have posted recently about it being an apples and oranges comparison, although I don’t agree that the breakeven point is 117 years or whatever. That seems like some ivory tower bs to me.

Originally posted by Vikram C.:
I do agree with your overall philosophy though. The ideal income tax is no income tax. And if you are going to have it, make it as simple and as flat as possible.

Agreed on flat taxes….not agreed on ideal tax being no tax. The government does provide some tangible functions like providing for our national defense and constructing infrastructure.

Originally posted by Vikram C.:
The only reason that I am not in favor of abolishing the deduction for mortgage interest is because it will further skew the tax bias against home ownership. As you know, landlords have a variety of tax benefits from their ownership of a property that owner-occupiers don't. I would not want to take away a further benefit from owner-occupiers and make the situation even more unfair.
Otherwise, we may find ourselves in the perverse situation where it is much more profitable for two neighbors to own each other's homes and rent them out than to own their own homes.

Here is where I think we disagree the most Vikram. There is no skewing against homeownership. Homeownership carries a bundle of rights that renters do not have an needs to be included in an analysis of which is a superior investing decision. I don’t think the decision should be made based solely on viewing your home as an investment and neither do others, which is why they rationally bid the prices above where they would be for a strictly discounted cash flow valuation. That is why SFRs are generally BAD investments unless they can be purchased at large discounts to intrinsic value.

Landlords may get favorable tax shield treatment, but tenants don’t. Tenants only share in this favorable treatment indirectly and thus it isn’t an easy thing to measure in the presence of a competitive market. The space market is generally pretty efficient, but it is far from perfect so it is apples and oranges to compare it to interest deductions.

Originally posted by Vikram C.:
I think the problem with inflated asset prices has been caused by a variety of factors such as (a) government guarantees of mortgages, (b) short-term executive compensation arrangements, (c) lack of shareholder rights, (d) non-recourse home loans and (e) the stupidity and greed of home buyers. I would not want to mess with the tax treatment of home ownership as a way to prevent a future bubble because it was never a cause in the first place.

a. Agreed…A lower cost of capital and payment myopia bid asset prices higher

b. Agreed…Build to sell instead of build to keep always creates a moral hazard

c. Agreed…Shareholders are neutered with current entity laws as you have pointed out in other posts

d. Strongly Disagree…The lender rationally will price their cost of capital higher in states with non-recourse laws or in transactions with non-recourse financing. There could be special cases for this like in leftist California where the government irrationally legislates below-market rates for lenders, but in the absence of this scenario the sophisticated lender will price their debt in a manner to compensate them for the risk

e. Agreed…Mostly with the stupidity argument. I would use ignorance instead because I think that many people are smart and don’t understand some items as well as an investor would…this doesn’t necessarily make them stupid
I agree that the tax treatment was not the cause of the bubble. I don’t know what the source of the changes are (Apparently Rich does!), but my suspicion is that it is a tax grab and has little to do with “fixing†the causes of the bubble.

Originally posted by Vikram C.:
In fact, I would argue that our mutual distrust of government interference in markets would cause us to want the government to give home owners all the normal deductions that investors get. Why should the government favor one form of ownership and structure over another? All investments in assets, including the ownership of one's own home OR a rental property, should get the exact same tax treatment. The government has no business micro-managing these things through disparate tax treatment.

AMEN! I agree with this wholeheartedly…regardless of whether or not it adds fuel to our current problem. I would rather take a “big bath†and fix the system entirely right now and suffer some short-term pain than to patch things and have the government orchestrate another screw-up going forward. The type of problems we have now are not possible without the government trying to socially engineer things, screwing them up, and causing depressions.