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Whither the mortgage interest tax deduction?

Tweaks to homeowner deduction -- seen as cornerstone of American Dream -- could be part of 'cliff' deal.

There is still much negotiating to do before there's any kind of deal on the fiscal cliff. But by most accounts virtually everything is on the table, including the mortgage interest tax deduction. The much loved and very expensive to the federal Treasury mortgage interest tax deduction.

Dan Schneider teaches third grade in the suburbs of Cleveland. He, his wife and two kids live in a small, 1940s bungalow. He loves the house.  And his mortgage interest deduction.

He says, “It’s important because it’s one of the only deductions that I get."

He’s not alone.  The deduction saves middle class homeowners $1,200-$2,600 a year on their taxes.  That’s according to the Wharton business school. Schneider usually gets a refund of a couple thousand dollars. So I don’t expect him to be too happy when I tell him there’s talk of changing, or even eliminating, the deduction.  But Schneider surprises me.

“If someone came along and said look the country is in trouble," he says. "We need to get rid of this deduction so we can balance the books,  and made it fair for everybody I would be on board.”

But how do you make it fair? Depends who you ask.

Anthony Sanders teaches real estate finance at George Mason University.  He says you should cap the deduction at $500,000. One of the recommendation of the Simpson-Bowles deficit reduction commission. Right now, rich people and movie stars get up to a million dollars in mortgage deductions.

“Brad Pitt should not be getting a mortgage interest deduction,” Sanders says.

Sanders says mortgage deductions for the middle class shouldn’t be touched. But Charles Campbell doesn’t think it’s enough to just target the rich. He’s a financial adviser, now with Eagle Financial Publications. He says the bulk of mortgage interest deductions go to the middle class, and deductions should be capped for everyone. Campbell says that might undercut the American Dream of owning a home.

“That’s what we were all told growing up -- hey, 2.1 kids and a white picket fence," he says. "Well, your white picket fence might just be an apartment building instead.”

And if you could afford to buy a home, it would be a bungalow -- not a McMansion.

About the author

Nancy Marshall-Genzer is a senior reporter for Marketplace based in Washington, D.C. covering daily news.
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It should be phased out humainly over a period of 10 years. It doesn't help affordability because a deduction received by everyone just creates price inflation by an equal amount since everybody gets the increased purchasing power. It's really a subsidy for the real estate and building industries. It encourages debt for a particular and non-productive asset class.

There is no such thing as a $1 Mil mortgage interest tax deduction. The rule is interest on a $1 Mil 1st mortgage is deductible. At today's mortgage rates a taxpayer with a 3.5% - $1M mortgage will be able to deduct $35k. They will not be able to deduct $1 mil. I'd appreciate it if you could note this during a future show. I'm a CPA. Its' rare that I hear accurate reporting on the subject of income taxes. But this one is so misleading I had to say something. Frankly does a $1M mortgage interest deduction even make sense? The home would have to cost $40M to generate a loan large enough to cost $1m in annual interest. Someone who can afford a $40M home likely doesn't have to borrow to do so.

You don't have to eliminate the mortgage-tax deduction to save money and make it fair. Here is what you do:
1. Limit the amount of tax deduction to interest on a conventional 30-year loan of 100% of the value of the average house in the area.
2. Limit the number of lifetime deductions to 2 per individual, 4 to a married couple.
3. Gradually phase out the primary-residence capital-gains-tax exemption over the next 10 years.
4. Reduce the deductible amount of (1.) progressively as the taxpayer earns more, eliminating it at $500,000 annual income.

This revenue enhancer allows most people to continue what they have been doing, discourages speculation and benefits those who really need it. Psst: Pass it on!

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