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Mortgage-cut value overblown
Myrtle Beach Sun News
10/21/2005
Note to Washington: Keep your grubby hands off our mortgage deductions!
Last week's papers carried accounts of an idea being considered by President Bush's tax-overhaul commission - to eliminate the vile alternative minimum tax by, among other things, trimming the break homeowners get on mortgage interest.
Currently, homeowners can deduct all the interest paid on mortgages of up to $1 million, often dramatically slashing their income tax. Various news accounts said the commission might recommend dropping that ceiling to $300,000 or $350,000.
Because the median home price nationwide is about $220,000, most homeowners would see no change in the deduction. But a $300,000 ceiling would hurt many homeowners in the higher-priced areas, such as the East and West coasts.
Imagine you had a $400,000 mortgage and were permitted to deduct interest paid on the first $300,000. Annual interest payments on the remaining $100,000 would be about $7,200. Losing the tax deduction on that would cost you about $1,800, assuming a 25 percent tax bracket.
Granted, many people with $400,000 homes could afford an $1,800 sting.
But would a cut in the interest deduction be the first step toward total elimination? Would loss of this deduction be offset by savings on the alternative minimum tax, which is affecting more middle-income taxpayers? Or would ordinary homeowners get the short end - paying for an alternative minimum tax elimination that mainly benefited the rich?
It's too soon to know. But for many homeowners, the mortgage-interest deduction is the biggest tax saver on the return. It's sacred.
Still, I think lots of homeowners overestimate this deduction's value and sometimes make unwise decisions as a result. Many people buy more home than they can afford on the theory a big interest payment will save them a lot of taxes. In fact, it doesn't make sense to pay another dollar in interest just to save 25 cents in tax.
Examples like the one above are typical, but they don't tell the whole story. Take, for example, a married couple with $100,000 in annual taxable income, filing a joint return. The first $14,600 is taxed at only 10 percent, the next $44,800 at 15 percent and the remaining $40,600 at 25 percent.
Although this couple is said to be in the "25 percent tax bracket," once the three rates are combined, the federal tax bite actually is about 18 percent.
Also, this assumed $100,000 in taxable income, which is what's subject to tax after various deductions are made. Many couples with $100,000 in gross income - before the deductions - actually pay 15 percent in federal income tax, perhaps less. This is called the "effective rate."
Using this figure, the mortgage-interest deduction isn't quite as valuable as it first appears.
There's no doubt the mortgage deduction does save homeowners something at tax time. It's not something to be given up lightly.
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