What Impact Will Potential Tax Reform Have on Florida Mortgages?

A tax-reform panel created by President Bush may propose reducing the deduction and capital-gains exemption. If this goes into effect, home owners will be faced with mortgages that are less tax-friendly within the next year.

The bipartisan panel met on Tuesday and is charged with making reforms to the tax code. The president instructed the group to come up with ways to make the tax code simpler, fairer and more geared to promoting economic growth. One of the supposedly intended goals is to make sure that any revised code continues to promote homeownership.

The current interest on mortgages up to $1 million may be deducted at a homeowner’s marginal (i.e. top) income tax rate. This is the rate on which their last dollar is taxed. Moreover, when selling a home, owners may keep $250,000 in capital gains - tax-free - if they’re unmarried, or $500,000 if they’re married and file jointly.

So who would benefit from these tax breaks? Expectantly, for anyone following this administration, the breaks would be heavily weighed toward high-income tax payers, said panel member James Michael Poterba, associate head of the economics department at MIT. The top 2.2% of tax returns claim 22% of the benefits from the mortgage-interest deduction, he stated.

Why is there a proposed change in the first place? The current code, due to a lack of exemption on capital gains earned on stocks and many bonds, disproportionately favors real estate over other investments, economists argue. They say that investment in other forms of capital would increase productivity and thereby economic growth at a much greater rate than a home purchase.

The final report from the panel is due on November 1. While no final decisions have been made on proposal for that date, among the options being considered are:

• Reducing from $1 million the size of a mortgage on which interest may be deducted.

• Replacing the mortgage-interest deduction with a tax credit, allowing all homeowners with a mortgage to get a tax break — not just those who itemize.

• Reducing the tax rate at which mortgage interest may be deducted. Likely a proposed rate would be a middle-income tax rate, such as 15% or 25%. That would preserve the benefits of homeownership for middle-income taxpayers, Poterba said.

• Reducing the total capital gains exempted from tax.

Members of the panel stressed that if any changes were made, there would have to be a gradual transition period so as not to upset the housing market. The transition might involve grandfathering in the tax breaks enjoyed by homeowners at the moment, or phasing them out slowly. The issue should become more clear in the next month or so and consumers in all tax brackets should keep a close eye on the proceedings.