Homes Face Tax Reform

November 18, 2005
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GRAND RAPIDS — Owners of modest homes stand to gain tax credits, while owners of more expensive homes stand to lose part of their tax deduction benefit if recommendations from the President’s Advisory Panel on Federal Tax Reform are adopted.

The proposals are opposed by many in the real estate and mortgage industries, both nationally and locally.

In a report issued Nov. 1, the panel proposed that instead of the current deduction for interest paid on up to $1 million of mortgage debt, homeowners would be given a tax credit of 15 percent of the interest paid on their principal residence — up to the price of the average home in their area, determined by using data from the Federal Housing Administration. There would be no credit for second homes, vacation homes or home equity loans, all of which are currently eligible for mortgage interest deductions.

The proposed limits on the worth of an “average home” principal residence are between $227,147 and $411,704 nationally, depending on the location. The current average sale price for a home in the Grand Rapids metropolitan area is $139,000, according to a report from the National Association of Realtors.

While those in lower tax brackets may gain from the change, those in high-income brackets could lose more than half of their tax deduction.

The report will be reviewed by Secretary of the Treasury John W. Snow, who will then make a recommendation to President George W. Bush.

According to the report, only 54 percent of taxpayers who pay interest on their mortgage currently receive a tax benefit, while under the proposed changes, 88 percent would receive a benefit.

“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,” according to the report.

But local experts see far-reaching negative impacts.

“My opinion is this will definitely cool off the residential real estate market,” said Rick Harris, professor of taxation at the Grand Valley State University Seidman School of Business. “People are going to buy less house because they don’t get a write-off.”

Said David Bird, president of Heartwell Mortgage Corp., “The home industry has been such a positive segment of our economy that it’s hard to understand why the administration would want to tinker with such a positive and successful segment. It would potentially damage the growth of that segment.”

The report recommends curtailing what it called a mortgage interest “subsidy” for vacation and luxury homes, as well as “reduce the incentive to take on more debt by eliminating the deduction for interest on home equity loans.”

Harris described that deduction as “a huge benefit for people of substance.”

“This is a tax increase for people who own these kinds of homes,” he said “It won’t affect the people who are in the 15 percent tax bracket.

“The bigger the house, the bigger the mortgage, the more this hurts you.”

The changes could influence people to buy smaller homes or not buy new homes, Harris said.

It would also change the “ideal” home to whatever the price is determined to be for an area. If the FHA determines the average price of a home in the area to be $300,000, then that is the new “ideal” price.

“If you buy a home for $300,000, you get the same write-off as the guy who buys the $800,000 home,” Harris said.

Greg Carlson of Five Star Real Estate said the proposed changes would impact both the buyer and the seller in real estate.

“Buyers are going to be able to afford less home,” he said.

He said that if there are now 100 people who could afford a home, and under the proposed changes there are only 50, sellers would lose half of their potential buyers.

“It will definitely be a negative impact,” he said. “The question is how much? … Either the buyers have to figure out another way to come up with more dollars to put down, or they have to go into an adjustable rate mortgage. You start looking at these different levels of things that could take place.”

Bird said the proposed changes would damage the real estate market and artificially lower prices.

“The Mortgage Bankers Association of America is very opposed to the proposal and is lobbying very aggressively to make sure it doesn’t get any traction at this point,” he said.

Bird said the changes would hurt all homeowners except those in the extremely low-income brackets.

“If your standard deduction is cut in half, that increase in interest that you are paying is a higher cost,” he said. “We don’t see it as a positive proposal at all. We are adamantly opposed to its passing and are working diligently to ensure that it doesn’t.”

According to the report, the proposed change would simplify the tax process because taxpayers would not have to decide whether to claim a standard deduction or itemize and claim the home mortgage interest deduction. But Lori Baker, tax partner at Adamy + Co. PC, said the process would be more confusing to many homeowners.

With the current system, homeowners can deduct interest on their mortgage from their taxable income, while in the new system, it would be a credit — an actual dollar amount that comes off the taxes owed. The proposed cap in the home value would also be confusing to those accustomed to claming their entire interest, she said.

According to the report, “estimates suggest that between 85 and 90 percent of home mortgages originated in 2004 would have been unaffected by the proposed Home Credit mortgage limit.” But Baker disagrees that the change would not negatively affect many homeowners.

“You have to have a pretty small house in order to not be affected,” she said.

The report recommends a five-year phase-in of the Home Credit to lessen the blow to those who purchased homes expecting the interest deduction to continue.

The advisory panel also recommends increasing the length of time a homeowner must use a house as a principal residence to qualify for a capital gains tax exemption. Currently homeowners must have lived in the home for two out of the last five years; the panel wants to increase the time requirement to three out of the past five years.    

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