Home loan interest tax deduction changes may be coming

Tax code changes may or may not help middle class Americans

Anyone who pays taxes knows that the American income tax code is anything but simple. The code now runs some 6000 pages and no one person really understands it. Instead of creating a simple tax structure, we have a complicated document that has been amended thousands of times to suit the needs of various lobbyists, industries and political parties. The result is a complicated document that forces most of us to seek professional help when it comes time to prepare our taxes.

President Bush has said that he would like to simplify the tax code, but doing so is harder than it seems. Any changes to the code must generate an identical amount of revenue while not increasing the tax burden on any particular economic class. In addition, the President has requested of his tax-reform panel that the tax code continue to promote home ownership. That particular requirement may bring about some changes in what has until now been regarded as a sacred cow - the income tax deduction for home mortgage interest.

The way the tax code is currently structured, individuals may deduct the interest from their home loans from their taxable income. Many Americans fail to benefit from this, as the standard deduction allowed all taxpayers often equals or exceeds the mortgage interest, effectively rendering it a non-deduction. Still, the deductibility of the interest, even only in theory, remains a popular incentive for individuals to purchase homes. Yes, the interest on a home loan may double or triple the cost of the house over the term of the loan, but “Hey! It’s deductible!”

Some possible changes that may be in the works include:

• Putting a cap on the deduction. Currently, mortgage interest may be deducted on homes of up to $1 million in price. In addition, the deduction occurs at the highest taxable rate applied to the homeowner, thus allowing more high income earners to benefit from the deduction than low income earners. It’s possible that the $1 million cap may be lowered to some smaller amount.
• Reducing the tax rate for the deduction. The rate could be lowered to a rate that would benefit those who have smaller homes and lesser incomes, favoring those in the middle-income 28% tax bracket, for example.
• Eliminating the deduction altogether and simply replacing it with a one-size-fits-all tax credit. This could benefit all homeowners, unlike the current code, which benefits only those homeowners who itemize their deductions on their tax returns.

It’s possible that some combination of those items above could be implemented, or none at all. A report from the panel is due soon, but recommendations from the panel are merely suggestions and are not mandatory. Any changes must be passed by Congress and in the last few years they have been reluctant to change the code except to favor higher income earners. It remains to be seen if Congress has the will to make changes that will benefit those in lower income tax brackets and those who have smaller, starter homes. Still, the fact that a panel is looking to make the changes is a good start.