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NEW YORK (CNN/Money) - There's been ample criticism of President Bush's bipartisan tax-reform panel for the recommendation that lawmakers downsize the mortgage tax break for homeowners.
In its final report to the Treasury Department, the nine-member panel suggested:
• Lowering the amount of a mortgage loan on which homeowners get a tax break for interest paid. Suggested caps: Between $227,000 and $412,000.
• Converting the mortgage-interest deduction to a tax credit equal to 15 percent of the interest paid up to the mortgage-interest cap.
• Eliminating the deduction for interest paid on second homes and home-equity loans.
• Lengthening the time taxpayers must own a principal residence before any gains from selling are tax free.
(For more details on each provision, see below.)
Spreading the mortage-interest break more evenly is one key reason for the change, the panel said, since currently only homeowners who itemize their deductions get the break. Under the proposed changes, all homeowners could claim the proposed home credit.
In 2002, of the 130 million federal tax returns filed, only 46 million were itemized. Of those, only 37 million taxpayers claimed the mortgage-interest deduction.
And among those who do itemize mortgage interest on primary mortgages, less than 10 percent have mortgages over $300,000, so many homeowners' loans aren't likely to exceed the panel's caps, said David Brunori, vice president of Tax Analysts.
Your home tax break: Current vs. proposed
Generally speaking, under the panel's proposals, 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.
We asked enrolled agent David Mellem of Ashwaubenon Tax Professionals to give us some sense of how homeowners' tax breaks under today's system would compare to those they'd receive under the proposed reforms.
(This is by no means a comprehensive look at how taxpaying homeowners would fare overall under the proposals. Tax analysts have yet to complete those scenarios.)
Married, with young kids: Here's what Mellem found for a married homeowner currently in the 25 percent tax bracket who itemizes deductions and plans to pay $18,000 in interest on a $300,000 mortgage in 2006.
Under the current system, thanks to the home-interest deduction, he'd reduce his taxable income by $18,000, lowering his tax bill by $4,500 (18,000 x 0.25).
In addition, if he has two children under 17, he'd get exemptions totaling $13,200 plus $2,000 from the child-tax credits, lowering his tax bill by another $5,300 ((13,200 x 0.25) + $2,000).
So combining those two sets of tax breaks, he'd cut his tax liability by $9,800 under the current system.
Under the panel's proposals, the new home credit would reduce his tax bill by just $2,700 (18,000 x 0.15).
But, like all taxpayers, he'd also be entitled to a family credit, which would take the place of the current standard deduction, the personal exemption and the child-tax credit. The family credit for a married couple with two kids would be $6,300.
Under the tax reform panel's proposals, then, he'd cut his tax bill by $9,000 ($2,700 home credit plus the $6,300 family credit), or $800 less than under the current tax code.
Married, dependent kids over 17: However, under the current system, if his two children were dependents over 17, he'd lose the child-tax credit, and thus reduce his tax bill by only $7,800. Under the proposed system, the family credit wouldn't change, so he'd do better.
Married or single, no kids: Married homeowners without kids would reduce their tax bill by $6,150 under the current tax code, which is $150 more than under the proposals. Single homeowners without kids would lower their tax liability by $5,325 under today's code, or by $975 more than under the proposed reforms.
But -- and it's a big but -- none of these calculations include the deductions for property taxes and state and local income taxes that homeowners who itemize are entitled to take under the current system but which are eliminated under the panel's proposals.
So for the married homeowner with two kids, assuming he deducts $10,000 for state and local income taxes and property taxes, he'd reduce his tax bill by another $2,500 ($10,000 x 0.25) on top of the $7,800 or $9,800, depending on his kids' ages.
That is, under the current system, his tax bill would be cut by between $10,300 and $12,300, more in both cases than the $9,000 he'd save under the panel's proposals.
Keep in mind two things, however:
- Taxpaying homeowners may enjoy tax breaks elsewhere under the reforms which can make up some of that difference. (Comprehensive analysis is still being conducted by tax experts.)
- And given how politically unpopular curbing home tax breaks are, don't count on changes yet.
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In its final report to the Treasury Department, the nine-member panel suggested:
- 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 would be lowered to levels on par with regional averages, which today would be in a range between $227,000 for lower priced housing markets to $412,000 for higher priced markets.
- 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 and 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.
- Eliminating the deduction for interest paid on second homes and home-equity loans.
- Lengthening the time taxpayers must own and use a principal residence before gains from the sale of the home can be exempt from tax. The panel suggested three out of five years, up from two out of five years under the current code.
- Giving current homeowners a 5-year transition period in which they could claim either the home credit or the mortgage interest deduction. In each year, the amount of mortgage loan principal on which they could deduct interest would decline until the fourth year, when it would be capped at the regional limit between $227,000 and $412,000.
For a look at other changes proposed by the panel, click here. And see why some of the assumptions the panel had to make may inflate the estimated cost of AMT reform, for which tax breaks like the mortgage deduction will help to pay for.
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