Home mortgage interest deduction
Encyclopedia
A home mortgage interest deduction allows taxpayers who own their homes
to reduce their taxable income
by the amount of interest
paid on the loan
which is secured by their principal residence (or, sometimes, a second home
). Most developed countries
do not allow a deduction for interest on personal loans, so countries that allow a home mortgage interest deduction have created an exception to those rules. The Netherlands
, Switzerland
, and the United States
each allow the deduction. In Belgium
, Ireland
and Sweden
, only a minor part of mortgage interest is deductible.
An indirect method for making interest on mortgage for personal residence tax deductible in Canada is through an asset swap, whereby the homebuyer sells his existing investments, purchases a house in full or in part by the sale, gets a mortgage on the house, and finally, buys back his investments with the money from the mortgage. The Supreme Court of Canada has ruled in 2001 in the Singleton v. Canada case that transactions in the asset swap are to be regarded as distinct, thus rendering the interest on home mortgage acquired as part of the asset swap tax deductible.
The home ownership rate in Canada is about the same as in the United States, but Canadians have about 70% equity in their homes on average (i.e., 30% mortgage debt), compared to only 45% average home equity in the United States.
proposed creating the deduction as part of his legislative plan for sparking the French economy. In August 2007, the Constitutional Council
, the highest court in France, struck down the mortgage interest deduction as unconstitutionally creating a tax advantage that goes far beyond its stated goal of encouraging non-homeowners to buy homes. The Court noted that the deduction would apply to people who already own homes.
Still in place currently, the mortgage interest tax deduction is subject to fierce debate, and a political issue during most recent elections. Although largely an emotional point of discussion with the Dutch electorate, and described by many as "political suicide", most Dutch people believe that that the mortgage interest tax deduction will eventually be reformed. Many reasons for abolishment have been identified, often fuelled by a political ideology (e.g. creating house price inflation, limiting government earnings in times of economic downturn, mortgage interest tax deduction is increasing already high tax levels in the Netherlands, benefiting high income individuals more disproportionally).
As it stands now, Dutch politicians and other organisations research possible strategies to end interest payments tax deduction and are fuelling public debate to prepare the Dutch public for eventual abolishment. Only 18% of the Dutch public support eliminating the mortgage interest deduction entirely.
, the United States allows a home mortgage interest deduction, with several limitations. First, the taxpayer must elect to itemize deductions, and the total itemized deductions must exceed the standard deduction
(otherwise, itemization would not reduce tax). Second, the deduction is limited to interest on debts secured by a principal residence or a second home. Third, interest is deductible on only the first $1 million of debt used for acquiring, constructing, or substantially improving the residence, or the first $100,000 of home equity debt regardless of the purpose or use of the loan.
Prior to the Tax Reform Act of 1986
(TRA86), the interest on all personal loans (including credit card debt) was deductible. TRA86 eliminated that broad deduction, but created the narrower home mortgage interest deduction under the theory that it would encourage home ownership. A New York Times article notes that, in 1913, when interest deductions started, Congress "certainly wasn't thinking of the interest deduction as a stepping-stone to middle-class homeownership, because the tax excluded the first $3,000 (or for married couples, $4,000) of income; less than 1 percent of the population earned more than that;" moreover, during that era, most people who purchased homes paid upfront rather than taking out a mortgage. Rather, the reason for the deduction was that in a nation of small proprietors, it was more difficult to separate business and personal expenses, and so it was simpler to just allow deduction of all interest.
In the United States, there are additional tax incentives for home ownership. For example, taxpayers are allowed an exclusion of up to $250,000 ($500,000 for a married couple filing jointly) of capital gains on the sale of real property if the owner used it as primary residence for two of the five years before the date of sale. Furthermore, U.S. taxpayers are not taxed on imputed income derived from home ownership. This can be explained by comparing a person who owns a home and rents it out to strangers. The rents received are included in the taxpayer's income. If this taxpayer rents a place to live because he chooses not to live in the home he owns, the payments he makes are not deductible because it would be a personal expense. Simply by evicting the tenant and moving into the home that he owns, this taxpayer avoids including the rent on his own home from his gross income.
strongly opposes eliminating the mortgage interest deduction, claiming, "Housing is the engine that drives the economy, and to even mention reducing the tax benefits of homeownership could endanger property values. Home prices, particularly in high cost areas, could decline 15 percent if recommendations to convert the mortgage interest deduction to a tax credit are implemented." The Tax Foundation
, a conservative think tank claims that economists are basically united in their opposition to the deduction. The Tax Foundation argues that few low- and middle-income taxpayers benefit, calling it subsidization of the real estate industry.
Some call the home mortgage interest deduction a part of the hidden welfare state
, whereby tax incentives subsidize wealthier people and corporations. Economist Edward L. Glaeser remarked in the New York Times that the policy "is public paternalism at its worst" and wrongfully "encourages people to leave urban areas" as well as to borrow as much as possible to bet on housing."
for home ownership. Countries that tax imputed income on home ownership may allow the deduction under the theory that it is no longer a personal loan, but a loan for income-producing purposes. Standard criticisms are that it does not significantly impact home ownership, that it allows taxpayers to circumvent the general rule that interest on personal loans is not deductible, and that the deduction disproportionately favors high-income earners.
A second justification applies to countries which tax imputed income on home ownership, such as Sweden, the Netherlands
, and Switzerland: since home ownership generates imputed income under such a system, the interest on the home loan is no longer a personal expense, but an expense necessary to "earn" the imputed income and therefore should be tax deductible. In fact, Sweden, the Netherlands, and Switzerland allow a home mortgage interest deduction.
Another standard criticism of the deduction is that it does not have a significant impact on home ownership rates.
Owner-occupier
An owner-occupier is a person who lives in and owns the same home. It is a type of housing tenure. The home of the owner-occupier may be, for example, a house, apartment, condominium, or a housing cooperative...
to reduce their taxable income
Taxable income
Taxable income refers to the base upon which an income tax system imposes tax. Generally, it includes some or all items of income and is reduced by expenses and other deductions. The amounts included as income, expenses, and other deductions vary by country or system. Many systems provide that...
by the amount of interest
Interest
Interest is a fee paid by a borrower of assets to the owner as a form of compensation for the use of the assets. It is most commonly the price paid for the use of borrowed money, or money earned by deposited funds....
paid on the loan
Loan
A loan is a type of debt. Like all debt instruments, a loan entails the redistribution of financial assets over time, between the lender and the borrower....
which is secured by their principal residence (or, sometimes, a second home
Second home
Second home may refer to:* Vacation property* Pied-à-terre* Second Home , an album by Marié Digby...
). Most developed countries
Developed country
A developed country is a country that has a high level of development according to some criteria. Which criteria, and which countries are classified as being developed, is a contentious issue...
do not allow a deduction for interest on personal loans, so countries that allow a home mortgage interest deduction have created an exception to those rules. The Netherlands
Netherlands
The Netherlands is a constituent country of the Kingdom of the Netherlands, located mainly in North-West Europe and with several islands in the Caribbean. Mainland Netherlands borders the North Sea to the north and west, Belgium to the south, and Germany to the east, and shares maritime borders...
, Switzerland
Switzerland
Switzerland name of one of the Swiss cantons. ; ; ; or ), in its full name the Swiss Confederation , is a federal republic consisting of 26 cantons, with Bern as the seat of the federal authorities. The country is situated in Western Europe,Or Central Europe depending on the definition....
, and the United States
United States
The United States of America is a federal constitutional republic comprising fifty states and a federal district...
each allow the deduction. In Belgium
Belgium
Belgium , officially the Kingdom of Belgium, is a federal state in Western Europe. It is a founding member of the European Union and hosts the EU's headquarters, and those of several other major international organisations such as NATO.Belgium is also a member of, or affiliated to, many...
, Ireland
Ireland
Ireland is an island to the northwest of continental Europe. It is the third-largest island in Europe and the twentieth-largest island on Earth...
and Sweden
Sweden
Sweden , officially the Kingdom of Sweden , is a Nordic country on the Scandinavian Peninsula in Northern Europe. Sweden borders with Norway and Finland and is connected to Denmark by a bridge-tunnel across the Öresund....
, only a minor part of mortgage interest is deductible.
Canada
Canadian federal income tax does not allow a deduction from taxable income for interest on loans secured by the taxpayer's personal residence. But homes used in businesses as a landlord who owns a rental residential property can deduct interest as any other reasonable business expense. The difference being the deduction is allowed only when the property is not used for the taxpayer's personal use but is used as in any other type of business. However, there may be additional exclusions for passive activity losses.An indirect method for making interest on mortgage for personal residence tax deductible in Canada is through an asset swap, whereby the homebuyer sells his existing investments, purchases a house in full or in part by the sale, gets a mortgage on the house, and finally, buys back his investments with the money from the mortgage. The Supreme Court of Canada has ruled in 2001 in the Singleton v. Canada case that transactions in the asset swap are to be regarded as distinct, thus rendering the interest on home mortgage acquired as part of the asset swap tax deductible.
The home ownership rate in Canada is about the same as in the United States, but Canadians have about 70% equity in their homes on average (i.e., 30% mortgage debt), compared to only 45% average home equity in the United States.
France
France does not allow a home mortgage interest deduction. In 2007, newly-elected President Nicolas SarkozyNicolas Sarkozy
Nicolas Sarkozy is the 23rd and current President of the French Republic and ex officio Co-Prince of Andorra. He assumed the office on 16 May 2007 after defeating the Socialist Party candidate Ségolène Royal 10 days earlier....
proposed creating the deduction as part of his legislative plan for sparking the French economy. In August 2007, the Constitutional Council
Constitutional Council of France
The Constitutional Council is the highest constitutional authority in France. It was established by the Constitution of the Fifth Republic on 4 October 1958, and its duty is to ensure that the principles and rules of the constitution are upheld.Its main activity is to rule on whether proposed...
, the highest court in France, struck down the mortgage interest deduction as unconstitutionally creating a tax advantage that goes far beyond its stated goal of encouraging non-homeowners to buy homes. The Court noted that the deduction would apply to people who already own homes.
India
Your home loan interest portion is deductible (under section 24(b)) up to 150 000 rupees in a tax year for acquiring or constructing a property. The deduction is available only when the construction is complete or you have possession of the property. Interest of pre-construction period is deductible in five equal instalments. The first instalment is deductible in the year in which construction of property is completed or property acquired. The principal is deductible under section 80C, which has a limit of 100 000 rupees.Netherlands
In the Netherlands, all interest payments can be deducted completely for a maximum period of 30 years. However, before deduction the taxable income is increased by a percentage of the property value (so-called "notional rental value" ), with the reasoning that the property has a potential income-generating purpose.Still in place currently, the mortgage interest tax deduction is subject to fierce debate, and a political issue during most recent elections. Although largely an emotional point of discussion with the Dutch electorate, and described by many as "political suicide", most Dutch people believe that that the mortgage interest tax deduction will eventually be reformed. Many reasons for abolishment have been identified, often fuelled by a political ideology (e.g. creating house price inflation, limiting government earnings in times of economic downturn, mortgage interest tax deduction is increasing already high tax levels in the Netherlands, benefiting high income individuals more disproportionally).
As it stands now, Dutch politicians and other organisations research possible strategies to end interest payments tax deduction and are fuelling public debate to prepare the Dutch public for eventual abolishment. Only 18% of the Dutch public support eliminating the mortgage interest deduction entirely.
United States
Under of the Internal Revenue CodeInternal Revenue Code
The Internal Revenue Code is the domestic portion of Federal statutory tax law in the United States, published in various volumes of the United States Statutes at Large, and separately as Title 26 of the United States Code...
, the United States allows a home mortgage interest deduction, with several limitations. First, the taxpayer must elect to itemize deductions, and the total itemized deductions must exceed the standard deduction
Standard deduction
The standard deduction, as defined under United States tax law, is a dollar amount that non-itemizers may subtract from their income and is based upon filing status. It is available to US citizens and resident aliens who are individuals, married persons, and heads of household and increases every...
(otherwise, itemization would not reduce tax). Second, the deduction is limited to interest on debts secured by a principal residence or a second home. Third, interest is deductible on only the first $1 million of debt used for acquiring, constructing, or substantially improving the residence, or the first $100,000 of home equity debt regardless of the purpose or use of the loan.
Prior to the Tax Reform Act of 1986
Tax Reform Act of 1986
The U.S. Congress passed the Tax Reform Act of 1986 to simplify the income tax code, broaden the tax base and eliminate many tax shelters and other preferences...
(TRA86), the interest on all personal loans (including credit card debt) was deductible. TRA86 eliminated that broad deduction, but created the narrower home mortgage interest deduction under the theory that it would encourage home ownership. A New York Times article notes that, in 1913, when interest deductions started, Congress "certainly wasn't thinking of the interest deduction as a stepping-stone to middle-class homeownership, because the tax excluded the first $3,000 (or for married couples, $4,000) of income; less than 1 percent of the population earned more than that;" moreover, during that era, most people who purchased homes paid upfront rather than taking out a mortgage. Rather, the reason for the deduction was that in a nation of small proprietors, it was more difficult to separate business and personal expenses, and so it was simpler to just allow deduction of all interest.
In the United States, there are additional tax incentives for home ownership. For example, taxpayers are allowed an exclusion of up to $250,000 ($500,000 for a married couple filing jointly) of capital gains on the sale of real property if the owner used it as primary residence for two of the five years before the date of sale. Furthermore, U.S. taxpayers are not taxed on imputed income derived from home ownership. This can be explained by comparing a person who owns a home and rents it out to strangers. The rents received are included in the taxpayer's income. If this taxpayer rents a place to live because he chooses not to live in the home he owns, the payments he makes are not deductible because it would be a personal expense. Simply by evicting the tenant and moving into the home that he owns, this taxpayer avoids including the rent on his own home from his gross income.
Opinions about the deduction
The National Association of RealtorsNational Association of Realtors
The National Association of Realtors , whose members are known as Realtors, is North America's largest trade association. representing over 1.2 million members , including NAR's institutes, societies, and councils, involved in all aspects of the residential and commercial real estate industries...
strongly opposes eliminating the mortgage interest deduction, claiming, "Housing is the engine that drives the economy, and to even mention reducing the tax benefits of homeownership could endanger property values. Home prices, particularly in high cost areas, could decline 15 percent if recommendations to convert the mortgage interest deduction to a tax credit are implemented." The Tax Foundation
Tax Foundation
The Tax Foundation is a Washington, D.C.-based think tank founded in 1937 that collects data and publishes research studies on tax policies at the federal and state levels. The organization is broken into three primary areas of research which are the Center for Federal Fiscal Policy, The and the...
, a conservative think tank claims that economists are basically united in their opposition to the deduction. The Tax Foundation argues that few low- and middle-income taxpayers benefit, calling it subsidization of the real estate industry.
Some call the home mortgage interest deduction a part of the hidden welfare state
Hidden Welfare State
The Hidden Welfare State is a term coined by Christopher Howard, professor of government at the College of William and Mary, to refer to tax expenditures with social welfare objectives that are often not included in discussions about the U.S. welfare state...
, whereby tax incentives subsidize wealthier people and corporations. Economist Edward L. Glaeser remarked in the New York Times that the policy "is public paternalism at its worst" and wrongfully "encourages people to leave urban areas" as well as to borrow as much as possible to bet on housing."
Opinions about the deduction
The standard justification for the deduction is that it gives an incentiveIncentive
In economics and sociology, an incentive is any factor that enables or motivates a particular course of action, or counts as a reason for preferring one choice to the alternatives. It is an expectation that encourages people to behave in a certain way...
for home ownership. Countries that tax imputed income on home ownership may allow the deduction under the theory that it is no longer a personal loan, but a loan for income-producing purposes. Standard criticisms are that it does not significantly impact home ownership, that it allows taxpayers to circumvent the general rule that interest on personal loans is not deductible, and that the deduction disproportionately favors high-income earners.
A second justification applies to countries which tax imputed income on home ownership, such as Sweden, the Netherlands
Income tax in the Netherlands
Income tax in the Netherlands is regulated by the Wet inkomstenbelasting 2001 .The fiscal year is the same as the calendar year. Before April 1 citizens have to report their income from the previous year...
, and Switzerland: since home ownership generates imputed income under such a system, the interest on the home loan is no longer a personal expense, but an expense necessary to "earn" the imputed income and therefore should be tax deductible. In fact, Sweden, the Netherlands, and Switzerland allow a home mortgage interest deduction.
Another standard criticism of the deduction is that it does not have a significant impact on home ownership rates.
See also
- InterestInterestInterest is a fee paid by a borrower of assets to the owner as a form of compensation for the use of the assets. It is most commonly the price paid for the use of borrowed money, or money earned by deposited funds....
- LoanLoanA loan is a type of debt. Like all debt instruments, a loan entails the redistribution of financial assets over time, between the lender and the borrower....
- Mortgage loanMortgage loanA mortgage loan is a loan secured by real property through the use of a mortgage note which evidences the existence of the loan and the encumbrance of that realty through the granting of a mortgage which secures the loan...
- Tax deductionTax deductionIncome tax systems generally allow a tax deduction, i.e., a reduction of the income subject to tax, for various items, especially expenses incurred to produce income. Often these deductions are subject to limitations or conditions...
- Taxable incomeTaxable incomeTaxable income refers to the base upon which an income tax system imposes tax. Generally, it includes some or all items of income and is reduced by expenses and other deductions. The amounts included as income, expenses, and other deductions vary by country or system. Many systems provide that...
- Tax policyTax policyTax policy is the government's approach to taxation, both from the practical and normative side of the question.-Philosophy:Policymakers debate the nature of the tax structure they plan to implement and how they might affect individuals and businesses .The reason for such foitution effect]],...
- Hidden Welfare StateHidden Welfare StateThe Hidden Welfare State is a term coined by Christopher Howard, professor of government at the College of William and Mary, to refer to tax expenditures with social welfare objectives that are often not included in discussions about the U.S. welfare state...