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Mortgage tax changes: Winners & losers
Here's a look at some issues concerning the tax reform panel's proposal to trim mortgage breaks.
October 25, 2005: 4:29 PM EDT
By Jeanne Sahadi, CNN/Money senior writer

NEW YORK (CNN/Money) - Americans love their home tax breaks.

So it's no surprise there's been plenty of criticism of the expected proposal from President Bush's bipartisan tax reform panel to downsize the mortgage tax break.

The nine-member panel is likely to suggest a two-part change in its final report due next week:

  • Lowering the mortgage interest cap, which is the amount of a loan on which homeowners would receive a tax break for interest paid. Currently, that cap is $1 million. It's likely to be lowered to levels on par with regional averages. The panel had discussed a range between $172,000 for lower priced housing markets to $312,000 for higher priced markets, but the numbers could be higher in the final report, said the panel's executive director, Jeffrey Kupfer.
  • Converting the mortgage interest deduction to a tax credit equal to 15 percent of the interest paid on loans up to the mortgage interest cap. Deductions reduce your taxable income but favor those who itemize and those in higher tax brackets. Credits, which are dollar-for-dollar reductions of the taxes you owe, benefit all taxpayers equally, said Mark Luscombe, principal federal tax analyst at CCH.

Who would benefit? Who wouldn't?

Generally speaking, the higher your mortgage loan and the higher your tax bracket, the more likely it is that you'll see less of a tax break than you would under the current system.

Take a new homeowner who pays $18,000 a year in interest on a $300,000 loan and itemizes his deductions on his federal return.

Under the current system, if he were in the 25 percent tax bracket, he'd reduce his taxable income by $18,000, for tax savings of $4,500 (18,000 x 0.25).

Under the panel's proposal, he'd only save $2,700 (18,000 x 0.15). That assumes the $300,000 loan doesn't exceed the mortgage-interest cap.

But if he were in the 15 percent tax bracket, he'd see no difference under either scenario.

It also may be the case for some homeowners that if they no longer can deduct their mortgage they may opt to stop itemizing altogether, instead taking the standard deduction plus the mortgage credit, if that would be allowed. In that case, conceivably they might enjoy tax savings equal to or greater than they would see under the current system.

As it is, the number of homeowners who take the mortgage-interest deduction is far smaller than the total number of homeowners who file tax returns.

Those who don't itemize take the standard deduction, which they could take even if they didn't own a home. In 2002, of the 130 million federal tax returns filed, only 46 million were itemized. Of those, 37 million taxpayers claimed the mortgage-interest deduction.

But among those who do itemize mortgage interest deductions on primary mortgages in a given year, only between 3 percent and 9 percent have mortgages over $300,000, said David Brunori, vice president of Tax Analysts.

Those taking the larger loans, of course, tend to be in the high-priced, high-income markets on the East and West Coasts. So those are the taxpayers who may see the biggest hit to their tax savings if the rules change.

On the other hand, if there will be tax reform, it's possible that what you lose in tax savings on your home you may make up for in new tax breaks elsewhere.

And by transitioning to a credit, far more homeowners would get to take a tax break on their mortgage.

What about current homeowners?

Members of the tax panel have said they would recommend provisions to protect existing homeowners from any abrupt change.

"The devil's in the details," Brunori said. If they put in a grandfather clause, the problem would be solved in terms of not pulling the rug out from under homeowners' feet. But it also means the move would raise less revenue than if the base of homeowners subject to the change was wider.

On the other hand, he added, "any other transition (besides a grandfather clause) would never fly from an administrative standpoint."

Will such a change push down housing prices or interest rates?

In determining how much house they can afford, home buyers do price in the deduction that they've come to expect, said Keith Gumbinger, vice president of HSH Associates. So a change that would make the tax break less favorable to those in higher tax brackets and in higher priced markets could put downward pressure on home prices.

The tax reform of 1986 ended certain tax breaks for those buying multi-family dwellings. Prices for rental buildings dropped for a period as a result.

But, noted Nicolas Retsinas, director of the Joint Center for Housing Studies at Harvard, that was an instance where a tax break was eliminated, not just modified as would be the case with a new mortgage tax break.

What's the point of change?

The move to a mortgage tax credit could satisfy a number of objectives:

-- It would more evenly distribute the tax break among taxpaying homeowners.

-- It potentially would foster greater economic growth by making other types of capital investments as attractive tax-wise as housing.

-- Most notably it would help compensate for revenue lost if the alternative minimum tax (AMT) is eliminated, another of the panel's suggestions. Eliminating the AMT is estimated to cost $1.3 trillion over 10 years.

The panel's final report will be the starting point in the debate over tax reform among those in the White House, the Treasury and Congress. But lawmakers are free to discard or amend any proposal put forth.

Translation: A whole lot of nothing – or a whole different something -- may result.

And it may be a while before any tax reforms are implemented. The last major overhaul of the federal tax code occurred in 1986, 10 years after tax-reform discussions began.

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