Home mortgage interest deduction

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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.

Status in countries

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 ^[1] 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,^[2] but Canadians have about 70%^[3] 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 Sarkozy proposed creating the deduction as part of his legislative plan for sparking the French economy.^[4] 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.^[5]

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.^[6]

Netherlands

In the Netherlands, all interest payments can be deducted completely for a maximum period of 30 years.^[7] However, before deduction the taxable income is increased by a percentage of the property value (so-called "notional rental value" ^[8]), 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.^[9] 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.^[10] 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).^{[11][12][13][14]}

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.^[15] Only 18% of the Dutch public support eliminating the mortgage interest deduction entirely.^[15]

United States

Under 26 U.S.C. § 163(h) of the Internal Revenue 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 (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.^[16] 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.^[17]

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 Realtors 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."^[18] The Tax Foundation, a conservative think tank claims that economists are basically united in their opposition to the deduction.^[19] The Tax Foundation argues that few low- and middle-income taxpayers benefit,^[20] calling it subsidization of the real estate industry.^[21]

Some call the home mortgage interest deduction a part of the hidden welfare state, whereby tax incentives subsidize wealthier people and corporations.^{[citation needed]} 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."^[22]

Opinions about the deduction

The standard justification for the deduction is that it gives an incentive for home ownership.^[16] 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^[16].

See also

• Interest
• Loan
• Mortgage loan
• Tax deduction
• Taxable income
• Tax policy
• Hidden Welfare State

References

1. ^ Supreme Court of Canada: Singleton v. Canada, 2001 2 S.C.R. 1046, 2001 SCC 61
2. ^ Worthwhile Canadian Initiative
3. ^ RBC 2008 Investor Day, Royal Bank of Canada, URL accessed 28 December 2008
4. ^ Bloomberg.com: Worldwide
5. ^ http://www.conseil-constitutionnel.fr/decision/2007/2007555/2007555dc.htm (French)
6. ^ http://mytaxes.in/index.php?topic=9.0 Home Loan Deduction
7. ^ http://www.belastingdienst.nl/variabel/buitenland/en/private_taxpayers/private_taxpayers-12.html
8. ^ http://www.belastingdienst.nl/variabel/buitenland/en/private_taxpayers/private_taxpayers-10.html
9. ^ http://www.nuzakelijk.nl/algemeen/2259623/verkiezingen-2010-hypotheekrenteaftrek-en-huur.html
10. ^ http://www.nrc.nl/krant/article1739149.ece/Taboe_voor_politici,_niet_voor_de_kiezers_
11. ^ http://nl.wikipedia.org/wiki/Hypotheekrenteaftrek
12. ^ http://nos.nl/artikel/65097-hypotheekrente-weer-ter-discussie.html
13. ^ http://www.bouwendnederland.nl/SiteCollectionDocuments/Argumenten%20voor%20-%20tegen%20beperking%20hypotheekrenteafttrek.pdf
14. ^ http://www.hypotheker.nl/Hypotheken/Hypotheekrenteaftrek/Veelgestelde+vragen/
15. ^ ^{a b} http://www.tns-nipo.com/pages/nieuws-pers-vnipo.asp?file=persvannipo\pol_woningmarkt-08062010.htm
16. ^ ^{a b c} Who Needs the Mortgage-Interest Deduction? - New York Times
17. ^ Who Needs the Mortgage-Interest Deduction? - New York Times
18. ^ NAR: Defending the Mortgage Interest Deduction
19. ^ The Case Against the Home Mortgage Interest Deduction
20. ^ Who Benefits from the Home Mortgage Interest Deduction?
21. ^ Some Facts About the Mortgage Interest Deduction
22. ^ http://economix.blogs.nytimes.com/2011/03/15/if-the-tea-party-went-downtown/