Mortgage Interest Tax Break To End Soon?

America has become known over the past three decades or so as the country where you buy a home, and instantly qualify for a tax deduction.  However, in today’s economy and in the aftermath of the financial and housing crisis, the tax break is in the process of debate.

The Mortgage Interest Deduction

Currently, homeowners that pay taxes and itemize their deductions are allowed to deduct the amount of interest they pay on their mortgages up to $1 million, as well as up to $100,000 for home equity loans.  A home equity loan is different than a mortgage due to the fact that the homeowner uses their actual home equity as borrowing collateral.  Additionally, homeowners are allowed this deduction on a second home as well, another reason the whole situation is currently up for debate.

Due to the continual talks regarding tax reform as well as the loopholes that must be closed if there is any chance of reducing the U.S. national debt, mortgage interest tax deductions are up for a variety of alterations, and there is also the chance that this tax break for homeowners may be completely eliminated.

The Cost of the Deduction

The mortgage interest deduction is quite costly for the Treasury, approximately $100 billion per year in revenues.  At this point, a host of politicians are looking to have this tax break for homeowners limited to a tax credit, possibly have the deduction completely eliminated, or minimize the deduction for those in the higher income brackets, which President Obama completely supports.

While the President and a variety of politicians are supporting these possible changes, there are definitely those that are against it, so there is potential for a long battle ahead.

According to figures documented by the Reason Foundation, households that utilized the deduction saved approximately $83 billion in taxes. However, approximately only 30 percent of all taxpayers even utilize this deduction each year, which clearly points to the savings being taken by those individuals in the high income brackets.

Canada and Great Britain

Currently, Canada does not allow for a deduction from taxable interest on any loan that has been secured by a Canadian taxpayer’s home.  As a result of this, Canadian home ownership hiked up approximately 70 percent in 2012 alone.

In the early 1980’s, Great Britain began to  phase out the tax deduction, and it was totally eliminated in 2000.  However, home ownership is currently at a low, dipping to 63.8 percent from 72.1 percent in 2001.  The main reasons for the slump are said to be the requirement of large down payments, stricter borrowing criteria, and higher overall prices on homes.

Eliminating of the Deduction

In addition to eliminating the deduction, the proposed bill would also eliminate tax benefits for homeowners with mortgages over $500,000, and President Obama has also proposed eliminating the tax deduction for homeowners that are above the 28 percent income tax bracket.

Governor Sam Brownback (R-KS), proposed at the local level an elimination on the mortgage interest tax deduction for all state taxpayers. While the proposal definitely had promise, a recent survey stated that approximately 63 percent of Kansas state taxpayers are opposed to this idea.

This is the type of public reaction that truly shows how hard it may be to actually make this change.  While phasing out these deductions will not have much of an impact on anyone except the 30 percent or so that actually utilize them, the battle may still be long and drawn out, simply due to the fact that many people simply do not like change, especially change that affects their bottom line.

Tax Payment Requirements on Forgiven Mortgage Debt

A Federal rule that has recently been announced about how mortgage debt forgiveness is handled in tax treatments might be changed in the near future. The new regulations will require all homeowners qualified for reduction of principal reduction under HAMP, the home loan modification program put forth by the government, to pay an extremely high tax bill that, unfortunately, many homeowners simply cannot afford. The good news is that there may be a loophole available for homeowners to be exempt from paying the high tax.

During the past five years, it was not a requirement for current homeowners to pay any tax on mortgage debt on their sole residence that they have been released from having to repay. This type of debt forgiveness typically comes from a reduced principal amount through the lender, a foreclosure, or a short sale of the home.

In today’s market, any homeowner that is eligible under HAMP for the reduction alternative program is automatically awarded a reduced mortgage balance, as well as additional options that ensure that their current payments do not exceed 31 percent of their total income. The reduction takes place over a span of three years, and during this time, the homeowner is expected to continue to make timely mortgage payments.

Typically, before the economic and housing crisis, the IRS would automatically tax homeowner reductions in the mortgage principal. Starting in 2007, the Mortgage Forgiveness Debt Act would eventually prove to work as a way to restrict the amount of foreclosures that were occurring, and the IRS decided that the reduction would be tax-free.

However, the question arises on whether or not this program will remain tax-free, or if the previous rules will set back in at the start of 2014. At this point in time, there are still millions of American homeowners that are struggling financially and have less than perfect credit. It is not certain how the implementation of the tax would impact them.

The good news is that there is definitely a way out of paying this tax. The IRS states that anyone participating in the program is allowed to claim the extent of their reduction in 2013, and they will not have to worry about paying any tax liability, even if the mortgage forgiveness law is not extended through 2014.

On the IRS website, there is a document stating the specific implications of principal reductions on homeowners that are participating in the HAMP program, stating that current participants as well as individuals that are considering HAMP application are allowed options.

Additionally, homeowners that were scheduled to start receiving the reductions over the following three years are allowed to change their schedules and claim their entire reduced principal amount in their past two years’ taxes by using a form 982 through the IRS. This is a detailed process, so anyone that has any questions or is looking to change their reduction schedule would greatly benefit by consulting with a tax specialist, or better yet, a HAMP counselor.

The simple reality to these potential changes is that current homeowners do have options. They do not need to wait and see what will happen as far as an extension on mortgage relief, they can take action today and protect their financial futures.