Home
Improvement
Don't Pay Off Your Mortgage!
Betsy Schiffman
The IRS
is delivering its message loud and clear: Taxpayers who take on debt to buy real
estate are good American citizens and will be richly rewarded. Americans who
take on debt to buy anything else will be penalized.
Hyperbolic? A little--but it's not far off. Some of the IRS' best tax breaks are
in real estate. For example, a couple that makes $500,000 on a home sale doesn't
have to give the IRS a single dime of it, according to the tax code. Would an
investor who made $500,000 selling shares of General Electric get off quite that
easily? Hardly.
|
|
|
|
|
|
On the other
hand, if a homeowner who was successfully able to pay off his mortgage after
many years suddenly needs to raise cash by taking out a new loan on his home, he
should be prepared to take a big tax bite.
As it
stands now, homeowners can deduct the entire interest paid on a mortgage (home
acquisition debt) up to $1 million--or $500,000 for couples that file
separately--a situation that usually applies to second mortgages as well. On
home equity debt--a mortgage taken out on a home that is used for anything other
than the home--the IRS only allows interest deductions on amounts up to
$100,000--or $50,000 for married couples that file separately.
That's
ten times less than what mortgage holders, who use the mortgage to buy a home,
are allowed to deduct. (The actual deduction varies depending on the loan.)
Many
people argue that this discrepancy is unfair and that the IRS is effectively
playing favorites with the housing industry. Larry Torella, a tax partner at New
York City-based accounting and advisory firm Eisner LLP, says the mortgage
interest deduction laws are an issue for many of his clients, but very few of
them ever are affected by the discrepancy.
"We
often advise our clients not to pay off their homes," Torella says. "We also
advise them to try to match any amount of money they take out on their home with
an equivalent sum on home improvements."
Of
course, it is in the government's interest, as well as the IRS', to promote
homeownership. Currently, the housing industry accounts for about 4% of the U.S.
gross domestic product.
To some
extent, however, deductions on mortgage interest encourage debt. And because
equity loans have become so readily available, if the IRS allowed interest
deductions on all loans--whether it's for a new home or a brand-new Jaguar--it
would likely lose a significant amount of revenue. A new bill written by
Republican New York congressman Tom Reynolds aims to balance the scale by giving
equal credits to both homeowners paying off mortgages and those paying off a
loan taken out on a fully owned property. It's not entirely clear how the
legislation will be received, especially since so many states are going through
budget crises and since tax hikes are a distinct likelihood.
The
legislation was first lobbied for by Neil Binder, a principal with real estate
company Bellmarc Companies in New York. Binder stumbled upon the glitch a few
months ago and was incredulous when he discovered that nobody could properly
explain it.
"I
called up about five or six attorneys I knew, and nobody knew about it. Then I
called up some accountants, and again, no one seemed to even be aware of it,"
Binder says.
To
demonstrate the discrepancy, Binder uses the example of a senior citizen--call
him Old Al--who buys a house in 1965 and finishes paying it off in 1995. He
unexpectedly falls ill and needs to take out a new mortgage on the home in order
to cover his new medical expenses. On the new mortgage, Old Al could only deduct
interest on the first $100,000, a significantly smaller deduction than he
previously had.
Although senior citizens who have paid off their homes are likely getting hit
hard by the tax code as it is right now, there are also probably a significant
number of high net worth individuals who pay for their homes in cash and, for
whatever reason, suddenly decide to take out an equity loan on their home.
While
lawmakers may be calling for revision of the penalties on home equity loans, for
the time being it makes sense to not pay off your mortgage. But what really is
called for is a more thorough overhaul of the tax code, one that encourages
Americans to invest and save, rather than being placed in the position of having
to re-mortgage their homes to be able to afford the things they can't pay for
because of taxes in the first place.
