A tax break that has long been untouchable could soon be in for some serious scrutiny. Many home buyers deduct their mortgage interest when assessing their tax bill, a perk that has helped bolster the income of millions of families – and the broader housing market. But as President Obama and Congress try to hash out a deal to reduce the budget deficit, the mortgage interest deduction will likely be part of the discussion.
Limits on a broad array of deductions could emerge in any budget deal. It is likely that any caps would be structured to aim at high-income households, and would diminish or end the mortgage tax break for many of those taxpayers.
Such a move would be fiercely opposed by the real estate industry. The industry has played a crucial role in defending the tax break, even as other countries with high home-ownership have phased it out. Housing market players who oppose any whittling down of the mortgage deduction still have plenty of time to press their case before Congress makes a decision. If President Obama and Congress do manage to reach an agreement to avoid the looming tax raises and spending cuts, their deal will be broad in nature. Then, over the following months, Congress will hash out details, like any caps on deductions.
“Until Congress introduces specific legislation, there's nothing to say about any proposed changes to the mortgage interest deduction,” Gary Thomas, president of the National Association of Realtors, said in an e-mailed statement. “However, it has always been the N.A.R.'s position that the mortgage interest deduction is vital to the stability of the American housing market and economy, and we will remain vigilant in opposing any future plan that modifies or excludes the deductibility of mortgage interest.”
One of the reasons the mortgage tax break is so vulnerable is that both Democrats and Republicans have recently favored capping deductions, including both President Obama and the recent Republican presidential nominee, Mitt Romney. What is more, deductions could be used to grease a compromise in the budget negotiations. High earners would be hit most by deduction limits, something that might make Republicans recoil. But the party may tolerate such a policy in return for a deal that limits how much actual tax rates go up for high-income households.
Taken on its own, the deduction limit wouldn't make a huge difference. But it can play an important role in a broad plan to cut the deficit, and shows a willingness to tackle once sacred cows. The tax numbers suggest it may not be hard to structure deduction limits in a way that leaves most middle-income households untouched.
Investors should remember that the mortgage interest deduction only applies to interest you pay on a loan secured by your primary home or a second home (that you live in for a portion of the year), but not to rental properties that you don't occupy.
However, the good news is that the costs of renting out investment property are generally tax deductible as business expenses. For instance, advertising, utilities, maintenance, insurance, taxes, and interest can be deducted from your rental income. Learn more in IRS Publication 527, Residential Rental Property and IRS Publication 535, Business Expenses.