As Congress looks for new sources of revenue to deal with the looming "fiscal cliff," a popular ingredient of the American dream could be on the chopping block.
It's the mortgage interest tax break, an especially popular deduction in high-cost places like the Bay Area, which allows taxpayers to cut their taxable income by the amount of interest they pay on their home loans.
Long seen as an untouchable "third-rail" in Washington, D.C., the break is now on the table as the Obama administration and Republicans look for more tax revenue. While the real estate industry argues the break is essential to keep the housing market healthy, some economists are not convinced, and the deduction is a fat target because it primarily benefits high-income households and those who live in expensive housing markets -- like this one.
"It's incredibly significant to me," said Satish Shenoy, who is shopping for a home in Silicon Valley for his young family. "The mortgage deduction is one big reason to buy a house, versus renting," he said.
Buying a home in the valley will mean taking on a $600,000 to $700,000 mortgage, said Shenoy, who manages cloud software sales for a Santa Clara-based telecommunications company. At a combined state and federal tax rate of 30 percent, that could mean $6,000 to $7,000 the first year in tax savings.
That hefty tax break -- multiplied by countless other homeowners across the U.S. -- explains why any move to trim the deduction will spark an epic battle. Any major change is likely to be phased in over many years.
The deduction can be taken for interest on mortgages up to $1 million for a first or second home and interest up to $100,000 in home equity loans. It reduced federal tax revenue by $80 billion in 2010, according to a study by Pew Charitable Trusts based on Treasury Department estimates, making it one of the biggest personal tax breaks.
Discussions in Washington currently center around some form of cap on all deductions. That would inevitably limit the mortgage interest deduction, which is one of the largest tax breaks in dollar amounts. The bipartisan Simpson-Bowles Commission advanced a proposal to cap qualifying mortgages at $500,000, give homeowners a 12 percent tax credit and eliminate the deduction for second homes and home equity loans.
Benefiting the most from the deduction are homeowners in high-cost areas such as California, Hawaii and New York, said Michael Gray, who operates a Silicon Valley accounting firm and the website taxtrimmers.com.
"It would have a very dramatic impact on the housing market" in these states, he said. "To do this when the housing market is already down, on its back and trying to get back up again -- I just don't see it happening."
The real estate industry argues that any abrupt elimination of the deduction would damage a fragile economy, cause home prices to drop and prevent some people from becoming first-time homebuyers.
"For some folks, that deduction makes the difference in their ability to maintain their status as homeowners," said David Stark, public affairs director of the Bay East Association of Realtors in Pleasanton.
National Association of Realtors chief economist Lawrence Yun argues that removing the deduction could lower property values by 15 percent, affecting even those who don't use the deduction.
But other economists say the housing market doesn't really need it, and argue that there's little evidence that it increases homeownership.
"There are lots of countries without it, and they seem to manage just fine," said Richard Green, director of the Lusk Center for Real Estate at the University of Southern California. Any changes should be phased in over a number of years, he added.
Studies show that its benefits are heavily skewed. "This is a tax benefit that accrues to high income, middle age and younger households," said Todd Sinai, a Wharton professor who has studied the deduction. "Those people tend to concentrate in suburbs of urban areas on the coasts."
Blacks and Hispanics get less benefit from it than whites, according to the Urban Institute's Tax Policy Center.
Renters can't take advantage of it, nor can many lower-income families, who are much less likely to itemize deductions.
"My personal view is that the mortgage interest deduction ought to be phased out entirely," said Reason Foundation economist Anthony Randazzo. "It could be phased out responsibly in a way that doesn't hurt people getting benefits now, and in a way to benefit people who don't claim the deduction now."
Three years ago, the Congressional Budget Office proposed reducing the maximum mortgage cap for a deduction gradually over 10 years to $500,000, which would raise $41.4 billion.
But that would have homeowners singing the blues in the jumbo loan territory of Silicon Valley.
In October, 40 percent of purchase loans in Santa Clara and San Mateo counties were for more than $500,000, according to DataQuick; 13 percent were for more than $800,000 and 10 percent were for more than $900,000.
"It's really unfortunate that a lot of people in Congress think somebody who has an $800,000 mortgage on a $900,000 house is a rich person," said Anne Walker with Advantage Real Estate. "Around here, it's an average house."
Contact Pete Carey at 408-920-5419.
Here are some proposals that are aimed specifically at the mortgage interest deduction:
Source: Congressional Budget Office, Joint Committee on Taxation, Urban Institute, Reason Foundation, Mercury News
Did you know? ...
Location, location, location: California homeowners deduct the most mortgage interest -- $96 billion in 2007, the most recent year data is available. That's 20 percent of the interest deducted for the entire country.
High income helps: About 76 percent of tax returns do not claim the mortgage interest deduction. The Congressional Joint Committee on Taxation estimates that 78 percent of the mortgage interest and property tax deductions went to households with incomes above $100,000, and 32 percent went to families with incomes above $200,000.
Reagan's sacred cow: During the negotiations that led to the tax reform act of 1986, then-President Ronald Reagan said the tax break was the one thing he wouldn't put on the table. Even so, Congress ultimately capped qualifying mortgages at $1 million and limited the interest deduction to home equity loans of $100,000 or less.
Source: Newspaper research