Tag Archives: tax code

Republicans and the Mortgage Interest Deduction

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photo by Nick Youngson

There is a lot to hate in the Republican tax reform plan contained in the proposed Tax Cuts and Jobs Act. (click here for a summary and here for the text of the bill itself). Overall, the bill is extraordinarily regressive, heavily favoring the wealthy. There will, of course, be all sorts of compromises to this proposal as Republicans work to get it passed. But it is worth highlighting what is good about the bill as it would be a shame to lose sight of it while the sausage is being made in Congress.

The best real-estate related provision from a policy perspective is the reduction of the mortgage interest deduction. In a section of the summary with the Orwellian title, Preserving the Mortgage Interest Deduction, the Republicans outline how they will slice the deduction in half:

For so many Americans, buying a home is often the largest investment – and perhaps most important – investment they will make in their lifetime.

The Tax Cuts and Jobs Act will continue to support the American dream of homeownership by preserving the Mortgage Interest Deduction.

This ensures that hardworking families can continue to access this important tax relief as they buy, own, and maintain their home.

Policy Specifics

• Increasing the standard deduction means a simpler, fairer, and flatter tax code in which fewer taxpayers need to go through the trouble of determining whether they should itemize.

• Under the Tax Cuts and Jobs Act, taxpayers will still be able to deduct mortgage interest in excess of the standard deduction, in combination with other remaining itemized deductions, including charitable contributions and property taxes.

• The mortgage interest deduction would be available for interest paid on new mortgages for up to $500,000 in home acquisition indebtedness on principal residences.

• For existing mortgages, the plan allows for current law deduction on indebtedness of up to $1,000,000 and up to $100,000 in home equity to help taxpayers who may have relied on the current mortgage-interest deduction.

How This Policy Helps the American People

Preserving the home mortgage – and the deduction for state and local property taxes – will help more Americans of all income levels achieve the American dream of homeownership. (15-16)

This plan would cut the principal amount of a mortgage that would be eligible for the mortgage interest deduction from the current maximum of $1,000,000 to $500,000. Given that wealthy households generally take the mortgage interest deduction more often and get more bang for their buck from it, it is a regressive aspect of the tax code.

It is striking that a provision with such broad support such as the mortgage interest deduction is actually on the table. It will be interesting to see how special interests in the real estate industry will respond. My bet is that at the end of day the deduction will remain mostly untouched, even though this particular Republican proposal makes good policy sense.

Rental Housing Landscape

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A Row of Tenements, by Robert Spencer (1915)

NYU’s Furman Center released its 2017 National Rental Housing Landscape. My two takeaways are that, compared to the years before the financial crisis, (1) many tenants remain rent burdened and (2) higher income households are renting more. These takeaways have a lot of consequences for housing policymakers. We should keep these developments in mind as we debate tax reform proposals regarding the mortgage interest deduction and the deduction of property taxes. When it comes to housing, who should the tax code be helping more — homeowners or renters?

The Executive Summary of the report reads,

This study examines rental housing trends from 2006 to 2015 in the 53 metropolitan areas of the U.S. that had populations of over one million in 2015 (“metros”), with a particular focus on the economic recovery period beginning in 2012.

Median rents grew faster than inflation in virtually every metro between 2012 and 2015, especially in already high rent metros.

Despite rising rents, the share of renters spending more than 30 percent of their income on rent (defined as rent burdened households) fell slightly between 2012 and 2015, as did the share spending more than 50 percent (defined as severely rent burdened households). Still, these shares were higher in 2015 than in 2006, and far higher than in earlier decades.

The number and share of renters has increased considerably since 2006 and continued to rise in virtually every metro from 2012 to 2015. Within that period, the increase in renter share was relatively larger for high socioeconomic status households. That said, the typical renter household still has lower income and less educational attainment than the typical non-renter household.

Following years of decline during the Great Recession, the real median income of renters grew between 2012 and 2015, but this was primarily driven by the larger numbers of higher income households that are renting and the increasing incomes of renter households with at least one member holding a bachelor’s degree or higher. The real median income of renter households with members with just a high school degree or some college grew more modestly and remained below 2006 levels in 2015.

Thus, the recent decline in the share of rent burdened households should be cautiously interpreted. The income of the typical renter household increased as the economy recovered, but part of this increase came from a change in the composition of the renter population as more high socioeconomic status households chose to rent their homes.

For almost every metro, the median rent in 2015 for units that had been on the market within the previous year was higher than that for other units, suggesting that renters would likely face a rent hike if they moved. The share of recently available rental units that were affordable to households earning their metro’s median income fell between 2012 and 2015. And in 2015, only a small share of recently available rental units were affordable to households earning half of their metro’s median income. (3, footnote omitted)

Foreclosure Body Count

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respres

Case Western’s Matt Rossman has posted Counting Casualties in Communities Hit Hardest by the Foreclosure Crisis (forthcoming in the Utah Law Review) to SSRN. The abstract reads,

Recent statistics suggest that the U.S. housing market has largely recovered from the Foreclosure Crisis. A closer look reveals that the country is composed not of one market, but of thousands of smaller, local housing markets that have experienced dramatically uneven levels of recovery. Repeated waves of home mortgage foreclosures inundated certain communities (the “Hardest Hit Communities”), causing their housing markets to break rather than bend and resulting in what amounts to a permanent transition to a lower value plateau. Homeowners in these predominantly low and middle income and/or minority communities who endured the Foreclosure Crisis lost significant equity in what is typically their principal asset. Public sector responses have largely ignored this collateral damage.

As the ten-year mark since the onset of the Foreclosure Crisis approaches, this Article argues that homeowners in the Hardest Hit Communities should be able to deduct the damage to their home values caused by the Crisis from their federal taxable income. This means overcoming the tax code’s usual normative assumption that a decline in a home’s value represents consumed wealth and, thus, is fully taxable. To do so, this Article likens the rapid, unusual and enduring plunge in home values experienced by homeowners in the Hardest Hit Communities to casualty losses – i.e. damages to personal property caused by a sudden force like a storm or a hurricane – which are deductible. The IRS and most courts have insisted this deduction is limited to physical damage. This Article carefully dissects the law and principles underlying the deduction to reveal that the physical damage requirement is overbroad and inequitable. When viewed in the larger context of other recent tax code interventions that allow those who have experienced personal financial harm due to a crisis to reduce their income tax base accordingly, home value damage in the Hardest Hit Communities actually fits comfortably within the concept of a casualty loss.

Notwithstanding its normative and equitable fit, the casualty loss deduction poses several administrative challenges in its application to the Foreclosure Crisis. This Article addresses each challenge in turn, explaining the extent to which the Treasury Department and the IRS, through administrative action and/or a careful application of case law precedent, can resolve it. The Article also identifies and grapples with the distributional reality that the casualty loss deduction, in its current form, provides a small or no return on lost home equity for a sizable number of low and middle income homeowners, which would make it a problematic method of recovery for homeowners in the Hardest Hit Communities. To make the deduction a better and more equitable fit under the circumstances, this Article identifies two, larger-scale modifications the federal government could adopt: (i) changing the method by which a casualty loss is valued for damage caused by the Foreclosure Crisis and/or (ii) lifting the floors and limits Congress has over time imposed on the deduction, as it has done for those taxpayers most heavily impacted by several recent hurricanes and droughts.

The article offers a creative response to ameliorate an aspect of the foreclosure crisis. Rossman concludes, “Once these homeowners are considered equally worthy of claiming a casualty loss, the question then shifts to how the IRS, the Treasury Department and/or Congress can best adapt and address the administrative and distributional challenges attendant to utilizing the casualty loss deduction in this context. These challenges are not insurmountable barriers, but rather issues to be carefully considered and strategically addressed.” (67)

I can certainly imagine some of those challenges, such as how to reliably identify a “permanent transition to a lower value plateau,” but articles of this type are just what we need as we try to figure out how to address housing crises of this magnitude.  While there was a big gap between the housing crises of the Great Depression and the Great Depression we can be sure that there will be another such event at some point in the 21st century.

Strange Love for Homeowner Tax Rates

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                                  Peter Sellers as Dr. Strangelove

With a nod to Dr. Strangelove, David Hasen has posted a scary little thought experiment, How I Learned to Stop Worrying and Love our Homeowner Tax Rules on SSRN. The essay “estimates the magnitude of life-cycle tax benefits available from home ownership for representative taxpayers.” (1)

Hasan starts with a not-that-far-fetched example of a couple who purchases a California home in the 1960s. The home passes to their daughter and son-in-law in 2013. he documents a federal and state tax savings of about $15,000 per year for every year the home is owned by the family.

Hasan concludes,

A large literature has examined the distributional and allocative effects of the homeowner tax rules described above. Summarizing, the literature notes that the rules favor homeowners over renters, owners of larger homes over owners of smaller ones, and residents of states with a large owner-occupied housing sector over residents of other states. The literature also notes the efficiency costs associated with the rules, as taxpayers respond by adjusting their economic positions in ways that reduce total social wealth. The responses may include holding property rather than selling it, occupying it rather than renting it, and swapping it rather than selling it for cash, all as described above. Each of these choices, when tax-motivated, creates real economic costs.

The contribution of the present discussion is modest. One largely hidden aspect of the rules has been just how large the dollar tax savings can be relative to affected taxpayers’ overall tax liabilities, especially when considered in life-cycle terms. The discussion above gives a sense of the numbers for a relatively typical, albeit profitable, course of investment over two generations for an upper-income, but by no means wealthy couple. The bottom line is that for such a couple, taxes are reduced by 40 to 50 percent.

Benefits that are heavily skewed to higher income taxpayers and, consequently, that undermine the general distributional structure headlined in the law promote neither civic pride nor a sense of common purpose; benefits that have massive allocative effects create a large drag on the economy. If I hadn’t learned to stop worrying and love our homeowner tax rules, I might even be upset myself. (10, footnotes omitted)

Academics, myself included, rail against the way that federal housing policy overwhelmingly favors owners (wealthier, on average) over renters (poorer, on average), primarily through the tax code. It does not seem like the political will is there to change that dynamic at present. Nonetheless, it is important to keep reminding everyone of the facts:  federal housing policy heavily favors the wealthy over the poor, a sure sign of a poorly designed social policy.