Mortgage Interest and Property Tax Deduction for Homeowners Who Don’t Itemize

The New York Times reported that Senate Democrats and Republicans reached a tentative deal on the new housing bill. Among the various provisions is a federal income tax deduction for property tax paid by taxpayers who don’t itemize deductions. Single taxpayers get a $500 deduction. Married taxpayers filing a joint return get $1,000. [Update: This has become law for 2008 and 2009. See follow-up post $500 Or $1,000 Property Tax Deduction for People Who Don’t Itemize Deductions.] Presidential candidate senator Barack Obama also proposed a "universal mortgage credit" which gives a refundable tax credit to taxpayers who pay mortgage interest but don’t itemize deductions.

The rationale behind these proposals is that the mortgage interest deduction and the property tax deduction benefit only the well-off. They say people who don’t itemize their deductions don’t get those deductions. From Obama’s Tax Fairness Plan:

"Owning a home is the culmination of the American dream that so many Americans work so hard for. The tax code is supposed to encourage home ownership with a mortgage interest deduction, but it goes only to people who itemize their tax deductions. Like so much in our tax code, this tilts the scales toward the well-off. The current mortgage interest deduction excludes nearly two-thirds of Americans who do not itemize their taxes."

Is that so? On the surface, yes. If you don’t itemize your deductions, you use the standard deduction, which in 2008 is $5,450 for single and $10,900 for married filing jointly. If you pay mortgage interest and/or property tax, but if they are not large enough, you still use the standard deduction. That’s why by definition Americans who don’t itemize their deductions don’t show a mortgage interest deduction on their tax return.

However, to say that those Americans don’t benefit from the mortgage interest deduction or the property tax deduction is a misunderstanding of how taxes and math work. The tax law says everybody is allowed to itemize their deductions. Everybody starts out listing their mortgage interest, property tax, state income tax, plus any other deductions they are allowed. Say for a married couple filing jointly, those deductions add up to $6,000, then the IRS tells them

"Guess what, you are lucky. We are going to let you deduct even more than what you’ve already got here. Would you like us to top off your deductions to $10,900?"

Now they can take the IRS up on the offer or say "no thanks" and stick to their original list of deductions, which include their mortgage interest, property tax, state income tax, and everything else. In reality, when one has less in deductions than the standard deduction, nobody declines the sweet offer from the IRS because they get to deduct all the deductions they are allowed, plus a bonus deduction offered by the IRS.

Now tell me who’s better off? The taxpayers who don’t itemize their deductions but end up deducting even more than their deductions, or the taxpayers who itemize their deductions? The non-itemizers get to deduct everything they are allowed plus a bonus deduction they receive from the IRS. Itemizers don’t receive such bonus. The non-itemizers are already better off than the itemizers. If we allow a new property tax deduction under the proposed housing legislation or a new "universal mortgage credit" under Obama’s tax plan, the non-itemizers will deduct their mortgage interest and property tax twice, plus taking a bonus deduction from the IRS. Does that sound fair to you?

I’m afraid our legislators and presidential candidates don’t understand how taxes and math work because they don’t do their own taxes.

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Comments

  1. Ken Clark - CollegeSavings.About.com says

    Yeah, this is kind of a wild deal… As always, lots of people getting wound up over a tax system that they don’t understand!

    :)

  2. Don says

    Well at least it brings one thing in line. I read a lot of financial blogs online and they are always pointing out how mortgages are better than other debt because you can deduct the interest.

    That may be for some people, but I couldn’t afford a house big enough to take that deduction. Now a mortgage can still be a reasonable kind of debt for me (has a low fixed interest rate, ends with me owning my home, etc.), but it has no special tax advantage.

    At least now, those authors will be able to point out that I save an extra $150 in federal taxes each year.

    Obama is right in one sense. If the point is to encourage home ownership, then the current tax setup doesn’t do that as well as it seems. It may be true, as you argue, that it isn’t unfair, but it also provides no incentive to people like me to own a home

    That might actually be a compelling point. If we encourage home ownership because of the other social advantages that go with it, then perhaps it is the less well-off that specifically need the incentive to own homes.

  3. Harry Sit says

    Anon – Making the mortgage interest deduction an above-the-line deduction will be criticized as a tax cut for the rich. How about getting rid of the standard deduction? That way people like Don will be encouraged to buy a house because they will see a difference in their tax bill when they do.

  4. Ted says

    Why is home ownership so great that we have to encourage it for everyone with more incentives?

    Maybe if our system hadn’t done this the past 8 years we wouldn’t have the subprime mess right now. Home ownership is not for everyone.

    Not only that, but this proposal will only encourage more borrowing by more low net worth people. Does that sound like something that is really going to help? Looks like a wolf in sheep’s clothing to me.

  5. Anonymous says

    “Anon – Making the mortgage interest deduction an above-the-line deduction will be criticized as a tax cut for the rich. How about getting rid of the standard deduction?”

    TFB, Getting rid of the standard deduction? Aren’t you talking about more tax on the poor?

    Either way will do it, but neither will pass the congress.

  6. stackingpennies says

    My idea: The tax is regressive anyway, get rid of it and give everyone an increased deduction. Renters indirectly pay that stuff in our rent. Also, you could take a HELOC and buy a plasma TV and deduct the interest.

    But it is probably too ingrained in the tax system to undo.

    Anyway, I read this awhile ago: http://www.nytimes.com/2006/03/05/magazine/305deduction.1.html?pagewanted=print

    I was surprised at the origins of this tax which I thought was there to help out the middle class.

  7. Harry Sit says

    StackingPennies – Thank you for the link to the good article by Roger Lowenstein. He is one of my favorite business writers. I remember reading it some time ago. It’s worth reading it again. Part of the URL in your comment is cut off due to formatting. Here it is again with hyperlink:

    Who Needs the Mortgage-Interest Deduction?

    Getting rid of the mortgage interest deduction will work too. It will remove the distortion in the housing market. I think mortgage interest in other countries like Canada and UK are not tax deductible. Their society functions just fine without it.

  8. Ted says

    If you wanted to get rid of the standard deduction and make it more “fair” for the poor you could just raise the personal exemption rate by $5,450. You would end up with the same “deduction” and everyone could deduct all of their mortgage interest.

  9. Anonymous says

    tfb,

    That’s a great piece of insight. I imagine I’ll be using this one next time someone talks about deductions.

    It’s amazing how something this obvious can still be promoted at a national level as a great idea.

    -John

  10. Jonathan says

    “I’m afraid our legislators and presidential candidates don’t understand how taxes and math work because they don’t do their own taxes.”

    Or they know perfectly well, but know this move and rhetoric will get them votes!

    I’ve never really understood the whole gov’t push towards homeownership, it just seems to inflate housing prices. But I’ll take the deduction since those are the rules of the game.

  11. MtnHermit says

    I know this is a fairly old entry but I was looking around, about to do my taxes, and stumbled upon it. I just had a couple of thoughts:

    Your post offers a strangely skewed perspective, and seems based on the erroneous presupposition that everyone has a mortgage and directly pays property tax. You said “Everybody starts out listing their mortgage interest, property tax…” and “…they can take up on the offer from the IRS or say “no thanks” and stick to their original list of deductions, which include their mortgage interest, property tax…”. Those statements are inaccurate.
    You ignore the fact that nearly a full third of the country does not own a home and because they don’t, they can’t benefit from mortgage interest and property tax deductions. Your definition of “Everybody” is inaccurate.
    For the purposes of gauging benefit of the mortgage interest and property tax deductions with regard to taking or not taking the standard deduction, there are 3 groups, not 2.

    1. People who benefit -Those who do itemize and take the deductions rather than the standard deduction
    2. People who don’t benefit – Those who could take the deduction, but choose the standard deduction
    3. People who can’t benefit – Those who can’t take the deductions and choose the standard deduction

    When you compare the groups accurately, it becomes clear that there is no benefit in the mortgage interest and property tax deduction to the roughly 1/3rd of the country that both have those expenses and don’t have high enough income and/or deductable expenses to itemize.

    The assertion, “…this tilts the scales toward the well-off”, from the Obama campaign literature is correct.

    -Dave

  12. Harry Sit says

    Dave – The then-proposed legislation (it’s the law now) and Obama’s plan were to give an extra tax deduction or tax credit to people who pay mortgage interest and/or property tax but don’t itemize, i.e. Group #2 in your comments. The post was written within this context. It’s not about whether mortgage interest or property tax should be deductible or whether the deductions benefit the rich more than the poor. It was about whether group #2 should be able deduct the same expense twice.

    As to Group #3, they are not left out either. Presumably they rent. Their rent pays the landlord’s mortgage interest and property tax. Because the landlord is able deduct those, the rent is lower than it otherwise will be. The renter’s tax deduction comes in the form of a lower rent.

  13. MtnHermit says

    You asked in your original post, “Now tell me who’s better off? The taxpayers who don’t itemize their deductions but end up deducting even more than their deductions, or the taxpayers who itemize their deductions?” or Who is better off? Group #1 or #2. Your entire post arbitrarily excluded group #3 It is clear when group #3 is taken into account, that group #1 is better off relative than group #2 than to group #3. By your logic, group #1 had the expense and took the deduction, group #2 had the expense and took the deduction, and group #3 did not have the expense and took the deduction.

    Why aren’t you asking: Why are the people in group #3 allowed a deduction for an expense they don’t even have?

    It is hard to take seriously, your assertion that group #2 is getting to deduct the same expense twice, when about half of the people taking the same deduction don’t have the expense in the first place.

    -Dave

  14. Harry Sit says

    Dave – I already said in my last comment that people in group #3 also have the expense. They pay the landlord’s mortgage interest and property tax. To the extent the lower rent don’t fully reflect the economic value, they are also given a standard deduction to cover those expenses.

  15. MtnHermit says

    So when a renter itemizes their deductions, what percentage or dollar amount of their rent is deductable as the part used to pay the landlord’s mortgage interest and property tax?

    I believe the answer is 0 regardless of how you calculate it. Mortgage interest and property tax deductions are not inherently part of the standard deduction except in so far as they had not specifically allowed separately before.

    Your argument does not hold up, and again, it is hard to take seriously, your assertion that group #2 is getting to deduct the same expense twice, when about half of the people taking the same deduction don’t have the expense in the first place.

  16. Harry Sit says

    Dave – We will have to disagree. I stated my reasoning and you stated yours. You keep saying half of the people don’t have the expense. Ask any renter, they will tell you they pay the landlord’s mortgage (not just interest) and property tax. And how many renters itemize deductions? For whatever it’s worth, CPA Kaye Thomas at Fairmark agreed with me. I also realize arguing about this is moot because it’s the law now for 2008 and 2009. The law does not have to make sense. See today’s new post.

    $500 Or $1,000 Property Tax Deduction for People Who Don’t Itemize Deductions

  17. sewall says

    Of course it is almost always wrong to think politicians care about math. They’re not in the math business. They’re in politics. If a proposal sounds good to focus groups and plays well politically then they’re for it. It is lovely when the math makes sense, but that is usually not their primary focus.

  18. drkhrse says

    There is fourth group. The 50% of the country that pays no federal tax but got a tax credit (rebated medicare and social security wages in effect from Obama where everyones debt went up). A fifth group which is the people on some kind of state or local program that subsidizes their rent, etc.

    What you fail to recognize is that most people rent when young, save up, and then buy a house. Most tax deductions for houses go away at seven years out of 30 because that is when the interest is paid down enough to start accruing principal. So, in a normal lifespan the mortgage deduction is about seven years total if one buys a home and keeps it.

    However, people get to use the deduction multiple times with refinancing and buying a new house, buying a second house to flip, etc. The Heloc to buy a flat screen tv being a good example of what the deduction shouldn’t be allowed for.

    The answer is simple. Only give the deduction on the first mortgage, eliminate it for refinance or subsequent purchases (and heloc). This is already done with capital gains where you get one freebee on a house sale. If that is in the code then certainly a first time home buyer type deduction can be in the code.

    I really find it alarming that in all of these discussions we don’t look at a progression over time of what success in America should be. Help the first time is a reasonable thing and prevents the abuses of house flipping, second mortgages you can’t afford, etc.

    I know someone who bought their first house late in life with an FHA loan (first time buyer will a low down payment). This is help from the government but help only once. The deduction should match this sentiment and should match the capitol gains tax code. His neighbor took a second mortgage and is now losing the house. He wonders whether the neighbors heart attack was due in part to stress over how to repay the second mortgage when the market went flat?

    For the renter whose chosen to never own a house, he knows that the mortgage deduction is only to get people on their feet in their first house and is not a renewable advantage for people to build up debt and get into trouble. In some respect his indignation is justified given the current crisis as he is not part of the problem.

    As far as deducting property tax, the renter should recognize it is money that pays for the renters roads, services, etc locally and a property tax deduction should not be argued as unfair.

    So no matter what groups you assign, most go through life being part of most of them. What we need is for the government not to be obligated to help forever and for the government to be able to help the newly adult or the new citizen. We should have a tax code that provides opportunity and not entitlement.

    After that, we let America do what it does best which is to be “the land of opportunity.”

    DRKHRSE

    If you do a little research on the sub prime mess you’ll be suprised to find out it wasn’t the first time home buyers as a lot of peole imply. Fanny and Freddie began speculating in derivatives like the rest of wall street and the government turned a blind eye (democrats not to blame for supporting home ownership but democrats to blame for not controlling the greedy people running Fanny and Freddie). I say democrats to blame as they’ve controlled congress since 2006 and the sub prime decisions at Fanny and Freddie were made about this time as well (Barney Frank was asleep at the wheel).

  19. Stuck in the Middle, Again says

    Dave, first off, thanks for going down the road you did. TFB, I find several things about your premise amusing. Your original assumption is that the standard deduction already has a property tax deduction built into it. Maybe, maybe not. One of the wildest variables – either way – are those unfortunate enough to have such high medical expenses, that itemizing would benefit them as well. Not exactly a rich vs other syndrome. Where I, based on my own simple logic, draw the line on property tax deductions, is that – if you are a homeowner – paying a mortgage high enough to itemize is often a personal choice; whereas paying property taxes is NOT a choice. Of course, the wealthier you are, the more “choice” becomes applied. That you would pick out this one issue – at worst a potentially TINY bonus to the middle class, is outrageous, with all the tax laws built for the sole purpose of the wealthy. Why do I say “for the sole purpose of the wealthy”?… Who else would be in a position to take advantage of those loopholes – I mean tax laws. Who else has the extra capital to play those games? Who else can afford to hire financial accountants & lawyers to play the game? And I’m not talking nickels and dimes here. I have a very simple solution regarding “fairness”, if “fairness” is your issue: a simple FLAT TAX RATE. The complex tax code could be blown up and simply re-written in a paragraph. The annual nuisance of doing taxes would be simplified and “fair” to all – or at least equally unfair to all. And tax accountants/lawyers/specialists would be a thing of the past. Hmmmm.. may have struck a chord there, I’m not sure. Considering your premise is coming from the classic :”screw the middle class, yet again, while the rich continue to frolic”, I’m curious what TFB stands for. I’m guessing the first and last initials are “too” and “bad”.

  20. Harry Sit says

    @Stuck – I wrote this article some time ago. Now I’ve come to senses to accept tax laws as they are. They don’t have to follow logic. They are a product of a political process. That was what seawall said succinctly in comment #18.

    Whether you lean left or right, merely complaining and hand-waving about their unfairness gets you nowhere. Don’t even waste time and keystrokes. I won’t waste my time any more. If you are still not happy about any tax laws, write to elective representatives, donate to and/or volunteer for campaigns, vote, or run for office.

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