RECOMMENDATIONS
Replace the deduction for mortgage interest with a Home Credit for all taxpayers equal to 15 percent of interest paid on a principal residence.
Establish the amount of mortgage interest eligible for the Home Credit based on average regional housing costs.
Lengthen the time a taxpayer must own and use a principal residence before gains from the sale of the home can be exempt from tax.
The Panel recommends that the deduction for mortgage interest be replaced with a Home Credit available to all homeowners. The Home Credit would be equal to 15 percent of mortgage interest paid by a taxpayer on a loan secured by the taxpayer’s principal residence and used to acquire, construct, or substantially improve that residence. The Panel recommends that the deduction for interest on mortgages on second homes and interest on home-equity loans be eliminated.
To encourage home ownership without subsidizing overinvestment in housing, the Panel recommends limiting the amount of the Home Credit. To adjust for variations in housing markets, the Panel recommends the Home Credit limit be based on the average cost of housing within the taxpayer’s area.
The Panel considered various ways to accomplish this, and determined the limit should be based on average area home purchase prices as determined using data from the Federal Housing Administration (FHA). The IRS currently uses a similar methodology to provide average purchase price guidelines for other tax provisions. The FHA insures loans of up to 95 percent of the median home sale price in a given metropolitan area, subject to certain minimum and maximum levels. To estimate average home purchase prices, the Panel considered a mortgage interest cap that was 125 percent of the median sale price for each county (this amount is approximately 31 percent higher than the FHA amount after grossing up the FHA median values from 95 to 100 percent). This would result in current limits between approximately $227,147 and $411,704. Estimates suggest that between 85 and 90 percent of mortgages originated in 2004 would have been unaffected by the proposed Home Credit mortgage limit (using the regional limits that would have been applicable for 2004).
The Home Credit would encourage home ownership, not big homes. More Americans would be able to take advantage of tax benefits for owning a home, while the current subsidy for luxury and vacation homes would be curtailed. In addition, the Home Credit would reduce the incentive to take on more debt by eliminating the deduction for interest on home equity loans.
As under current law, mortgage lenders would be required to report the amount of interest eligible for the Home Credit to borrowers on annual information returns. The Home Credit would simplify tax filing because taxpayers would not need to
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determine whether they are better off claiming the standard deduction or itemizing and claiming the home mortgage interest deduction.
More importantly, under the proposal, millions of Americans would be able to claim a tax benefit for home mortgage interest for the first time, which would make owning a home more affordable. Currently, only 54 percent of taxpayers who pay interest on their mortgages receive a tax benefit. As detailed in Figure 5.7, approximately 88 percent of taxpayers who pay mortgage interest would receive a benefit for home ownership under the Panel's recommendations. Lower-income taxpayers, in particular, would do better under the Panel’s recommendations than under the current system. For example, the percentage of taxpayers with adjusted gross income between $40,000 and $50,000 who have mortgages and receive a tax benefit for mortgage interest paid would increase from less than 50 percent to more than 99 percent. Depending on the year, between 77 and 94 percent of taxpayers with adjusted gross income over $100,000 who would receive a lesser subsidy under the Home Credit would have paid higher taxes under the AMT, which would be eliminated under the Panel’s options.
The Panel recognizes that limiting the amount of the current tax subsidy for mortgage interest could adversely affect individuals who purchased or refinanced homes assuming they would be able to deduct interest on up to $1.1 million of mortgage debt. To be fair to those who relied on current tax law in making important financial decisions, the options provide for a gradual phase-in of the cap over a five-year period for preexisting home mortgages. Additional information regarding the Home Credit, including the proposed transition relief can be found in the Appendix.
Under current law, up to $500,000 of capital gains on a home that a taxpayer has owned and used as his principal residence for two out of the last five years may be excluded. Although the Panel believes the exemption for gains from the sale of a principal residence should be retained for most homeowners, it also believes that the
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length of ownership and use required to obtain this benefit is too short. The Panel recommends that the length of time an individual must own and use a home as a principal residence to qualify for the tax exemption be increased from two out of five years to three out of five years. |
