Myth... Not all mortgage interest is tax deductible!

Discuss all general (i.e. non-personal) investing questions and issues, investing news, and theory.

Myth... Not all mortgage interest is tax deductible!

Postby mptfan » Wed Jan 21, 2009 1:42 pm

I hear variations on this myth repeated so often, without any qualification in the financial media. It takes various forms, but it usually goes something like this....

"If your mortgage interest rate is 6%, and you are in the 25% tax bracket, you are only paying 4.5% after taxes."

Well, this is simply not true for many people. The fact is that some people get no tax benefit at all for paying mortgage interest. And even those that do may only get a partial tax benefit. This is because every taxpayer can choose between itemizing their deductions or claiming the standard deduction, and you can claim the standard deduction regardless of whether you qualify for any itemized tax deductions. According to the IRS, most taxpayers take the standard deduction (I think around 65% of all tax filers). So, most people do not get the benefit of the mortgage interest tax deduction, and even those that do only benefit to the extent that the total of itemized deductions exceeds the standard deduction.

For example, the standard deduction in 2009 for married couples filing a joint return is $11,400. So, if a couple adds up all of their itemized deductions (including mortgage interest) and the total is less than $11,400, then they get no tax benefit whatsoever from paying mortgage interest. And even if the total is more than $11,400, they only benefit to the extent that the total of their itemized deductions exceeds the standard deduction.

Let's assume the couple has a $150,000 mortgage at 6%, so they pay $9,000 in interest, and their property tax bill is $2,000, and they gave $400 to charity, and they have no other itemized deductions. In their case, the total of their itemized deductions equals the standard deduction, so they get no tax benefit at all for paying all of that mortgage interest. So their before tax 6% mortgage interest rate is also 6% after taxes.

Let's now assume the couple has a $200,000 mortgage at 6% and they are in the 25% marginal tax bracket. Then they will pay $12,000 in mortgage interest, and their total itemized deductions would be $14,400, and they would get a tax benefit equal to $750. ($3,000 x .25) In that case, the relatively small additional tax deduction lowers their effective mortgage interest rate from 6% to 5.62%, not 4.5%. ($11,250 / $200,000).
If the couple is over 65, then the standard deduction is even higher...$12,500, so the tax benefit of the mortgage interest is reduced even further.
Of course it is possible for someone to have sufficient other itemized deductions (other than the mortgage interest deduction) that add up to more than the standard deduction, so that all of the mortgage interest then becomes tax deductible. But this applies to a minority of taxpayers, and I suspect it is a relatively small minority at that. But that doesn't stop the media and most people from simply repeating the mantra that "mortgage interest is tax deductible" so often, that most people simply don't understand that it probably doesn't apply to them, and they are surprised to learn otherwise.
Last edited by mptfan on Wed Jan 21, 2009 3:19 pm, edited 6 times in total.
mptfan
 
Posts: 3046
Joined: Mon Mar 05, 2007 10:58 am

Postby DSInvestor » Wed Jan 21, 2009 1:55 pm

mptfan, thanks for posting this. For users of tax preparation software such as turbotax or taxcut, they can easily determine the tax benefit of the mortgage interest by entering ZERO for mortgage interest after all other data has been entered. The difference in the tax is the tax benefit of the mortgage interest. Folks that live in states with high income tax (California, NY etc) are likely to benefit more from mortgage interest deduction because state income tax withholdings are a deduction (see line 5 in 1040 schedule A).
DSInvestor
 
Posts: 6536
Joined: Sat Oct 04, 2008 12:42 pm

Postby gt4715b » Wed Jan 21, 2009 2:14 pm

This is a good point. If you look at the form for itemizing deductions, the most common deductions are property taxes, local income taxes and charitable donations. If you're married you probably aren't getting the full tax benefit on the mortgate interest since it doubles the standard deduction whereas your property taxes are the same. This is especially true if one person isn't working or doesn't earn much.

I'm single, live in a relatively high income tax state and contribute a lot to charity so I get the vast majority if not all of the tax benefit, but I'm in the minority.
gt4715b
 
Posts: 330
Joined: Mon Jun 11, 2007 11:29 am

Postby tfb » Wed Jan 21, 2009 2:19 pm

DSInvestor wrote:Folks that live in states with high income tax (California, NY etc) are likely to benefit more from mortgage interest deduction because state income tax withholdings are a deduction (see line 5 in 1040 schedule A).

Or wait until you are eligible for AMT, then mortgage interest is one of few items still deductible under AMT (state income tax and property tax are not).
Harry Sit, taking a break from the forums.
User avatar
tfb
 
Posts: 6675
Joined: Mon Feb 19, 2007 6:46 pm

Postby yobria » Wed Jan 21, 2009 2:24 pm

Don't forget the largest itemized deduction - state taxes (sales or income). This is especially valuable for homeowners who have higher than average incomes. Mortgage interest is also deductible at the state level.

Nick
yobria
 
Posts: 5978
Joined: Tue Feb 20, 2007 12:58 am
Location: SF CA USA

Postby Ted Valentine » Wed Jan 21, 2009 2:49 pm

Very true. Good post.

I've been a homeowner for 10 years and have itemized only about 6 of those years. I recently refinanced to a lower rate and shorter term and will likely not be able to itemize for 2009.

The good side to not deducting mortgage interest is carrying less debt and most importantly sending less money to the bank!
Although our intellect always longs for clarity and certainty, our nature often finds uncertainty fascinating.
User avatar
Ted Valentine
 
Posts: 1540
Joined: Tue Jul 10, 2007 11:28 am
Location: Music City USA

Postby dm200 » Wed Jan 21, 2009 2:57 pm

For folks on the edge of having enough deductions to itemize, what sometimes helps is to move deductible items from one year to another.

Let's say you need over $10,000 in deductions to itemize, and you have about that amount every year. Let's say that you have $500 per month in mortgage interest, and $200 per month in charitable donations. In December of one year (say 2009), you pay the mortgage payment due in early 2010 - thereby getting an added $500. You also, in December 2009, make $400 in charitable donations you might otherwise make in jan and Feb 2010. You can then itemize in 2009. Then, itemize every other year.
User avatar
dm200
 
Posts: 6666
Joined: Mon Feb 26, 2007 3:21 pm
Location: Washington DC area

Postby livesoft » Wed Jan 21, 2009 3:07 pm

I thought the largest itemized deduction was charity?

Don't forget that bunching of deductions into every other year can be very helpful tax-wise (as dmr200 wrote).
Last edited by livesoft on Wed Jan 21, 2009 3:17 pm, edited 2 times in total.
livesoft
 
Posts: 33341
Joined: Thu Mar 01, 2007 9:00 pm

Postby DSInvestor » Wed Jan 21, 2009 3:07 pm

Ted Valentine wrote:The good side to not deducting mortgage interest is carrying less debt and most importantly sending less money to the bank!


Not deducting mortgage interest, by itself, has no affect on the amt of money you send to the bank and the amt of debt. However, if a homeowner realizes that they can't itemize and benefit from the mortgage interest deduction, it may make sense to send more money to the bank in the form of extra principal payments which in the long run will reduce the total interest paid the bank.
DSInvestor
 
Posts: 6536
Joined: Sat Oct 04, 2008 12:42 pm

Postby nisiprius » Wed Jan 21, 2009 3:13 pm

Yes, this a very good point, and one that is discussed at length in Kotlikoff and Burns' (flawed) book Spend 'Til The End.

Tax breaks are often oversold by people pitching financial products that qualify for them, and I'm convinced that some people are so thrilled by the idea of keeping money out of the hands of the IRS that they'd far rather save a dime on taxes than earn an extra dollar.
Last edited by nisiprius on Wed Jan 21, 2009 6:27 pm, edited 1 time in total.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.
User avatar
nisiprius
Advisory Board
 
Posts: 25278
Joined: Thu Jul 26, 2007 10:33 am
Location: The terrestrial, globular, planetary hunk of matter, flattened at the poles, is my abode.--O. Henry

Postby paulob » Wed Jan 21, 2009 3:22 pm

My itemized deductions for taxes is > than the standard deduction.

So, my interest is 100% deductible.

And I understand your point. But its not a myth, but perhaps just overstated.
Paul
User avatar
paulob
 
Posts: 1408
Joined: Tue Feb 20, 2007 8:54 am

Postby mptfan » Wed Jan 21, 2009 3:25 pm

paulob wrote:My itemized deductions for taxes is > than the standard deduction.

So, my interest is 100% deductible.


Your interest is only 100% deductible if your itemized deductions, excluding mortgage interest, is greater than the standard deduction.
mptfan
 
Posts: 3046
Joined: Mon Mar 05, 2007 10:58 am

Postby bottlecap » Wed Jan 21, 2009 3:27 pm

Great post. You always have to remember to consider all the moving parts of deductions. Most probably don't think that through, but then again, most people probably don't do their own taxes!
User avatar
bottlecap
 
Posts: 3255
Joined: Wed Mar 07, 2007 12:21 am
Location: Tennessee

Postby DSInvestor » Wed Jan 21, 2009 3:30 pm

nisiprius wrote:
Tax breaks are often oversold by people pitching financial products that qualify for them, and I'm convinced that some people are so thrilled by the idea of keeping money out of the hands of the IRS that they far rather save a dime on taxes than earn an extra dollar.


bold = my emphasis.

I have made the same observation. This is a very expensive way to keep money out of the hands of the IRS. I have had a mortgage with citimortgage - did some of my interest payments go to fund fat cat CEO severance packages or executive bonuses?
DSInvestor
 
Posts: 6536
Joined: Sat Oct 04, 2008 12:42 pm

Postby spangineer » Wed Jan 21, 2009 5:35 pm

nisiprius wrote:I'm convinced that some people are so thrilled by the idea of keeping money out of the hands of the IRS that they far rather save a dime on taxes than earn an extra dollar.


Guilty as charged, though not dimes per dollar. I'd much rather give $1000 ($2000, through my employer's matching donation program) to charities that support causes I support than send $250 to the federal government, which supports with near exclusivity causes of which I do not approve.

I want all my income to be put to good use, not just my net. Keeping as much money as legally possible out of the federal government's hands is, in my opinion, one way to do that.

And yes, Atlas Shrugged is my favorite novel. :D
User avatar
spangineer
 
Posts: 44
Joined: Sat Feb 24, 2007 10:39 am

Postby plake15 » Wed Jan 21, 2009 5:46 pm

If anyone ever read Gotcha Capitalism by Bob Sullivan,he lists the 10 biggest rip off in terms of fees and society perception in general..

Cell phone bills, credit-card bills, cable bills, hotel bills, retirement plans, gym memberships, bank statements, mortgages and student loans..

Mortgages are #1 by far on his list..It even has coined it's own term among it's industry for "DAF" fee..

Many people are so overwhelmed when buying a home that they fail to notice the hefty premium they pay for title insurance as part of their closing costs. Most buyers don’t ask any questions and simply go with the title company recommended by their real estate agents or banks.Search fees, document-preparation fees, escrow fees, closing fees, courier fees etc.....

The homeowner tax savings are so overstated by mortgage lenders and the industry in general because they know how easy it is to get an overwhelmed unknowledge buyer in it's pocket when they "show you the money you saved from going to Uncle sam" they will print out spreadsheets and have them to ready to go..But I have never seen one home lender have spreadsheet of the hundreds of thousands that you pay in interest over the life of the loan(even after the tax savings) that will go to some CEO retirement party in a decade or so..
Last edited by plake15 on Wed Jan 21, 2009 10:22 pm, edited 1 time in total.
plake15
 
Posts: 1043
Joined: Sat Oct 06, 2007 9:28 am

Postby paulob » Wed Jan 21, 2009 5:54 pm

mptfan wrote:
paulob wrote:My itemized deductions for taxes is > than the standard deduction.

So, my interest is 100% deductible.


Your interest is only 100% deductible if your itemized deductions, excluding mortgage interest, is greater than the standard deduction.


That is what I said. The taxes I itemize, e.g. real estate, income, etc. are by themselves above the standard deduction. So, again, my interest is 100% deductible.
Paul
User avatar
paulob
 
Posts: 1408
Joined: Tue Feb 20, 2007 8:54 am

Postby Enzo IX » Wed Jan 21, 2009 6:01 pm

I think it also gets gradually phased out for the high income people.
Enzo IX
 
Posts: 176
Joined: Wed Jul 23, 2008 5:07 am

Postby paulob » Wed Jan 21, 2009 6:21 pm

Enzo IX wrote:I think it also gets gradually phased out for the high income people.


Not phased out, just reduced.
Paul
User avatar
paulob
 
Posts: 1408
Joined: Tue Feb 20, 2007 8:54 am

Postby nisiprius » Wed Jan 21, 2009 6:33 pm

plake15 wrote:The homeowner tax savings are so overstated by mortgage lenders and the industry in general because they know how easy it is to get an overwhelmed unknowledge buyer in it's pocket when they "show you the money you saved from going to Uncle sam" they will print out spreadsheets and have them to ready to go..But I have never seen one home lender have spreadsheet of the hundreds of thousands that you pay in interest over the life of the loan(even after the tax savings) that will go to some CEO retirement party in a decade or so..
I'm not sure what you're saying here. No, they don't show you how much you'll contribute to some CEO's retirement party, but I assume that you are still given the same kind of Truth-in-Lending statement I was given in 1976, which clearly spelled out the number of dollars of interest I would be paying.

That statement was relatively new in 1976, and it was noticeable that everybody at the table, including my own lawyer, hated to give it to me and were all chuckle-chuckle implying that it was some unimportant piece of arcana required by some silly government regulation, and I shouldn't really feel obliged to pay any attention to it. Obviously they were scared that if people knew how much a mortgage cost, they'd run screaming out of the room and back to their rental apartment.
Last edited by nisiprius on Wed Jan 21, 2009 6:53 pm, edited 1 time in total.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.
User avatar
nisiprius
Advisory Board
 
Posts: 25278
Joined: Thu Jul 26, 2007 10:33 am
Location: The terrestrial, globular, planetary hunk of matter, flattened at the poles, is my abode.--O. Henry

Re: Not all mortgage interest is tax deducti

Postby paulob » Wed Jan 21, 2009 6:41 pm

mptfan wrote:Of course it is possible for someone to have sufficient other itemized deductions (other than the mortgage interest deduction) that add up to more than the standard deduction, so that all of the mortgage interest then becomes tax deductible. But this applies to a minority of taxpayers, and I suspect it is a relatively small minority at that.


I referenced Taxcut for a report showing IRS national averages for incomes of $50,000 - $99,999. The average National Average deduction excluding interest is $10,249. Subtract that from your cited 2009 std deduction of $11,400 leaves $1,151. If you subtract that from the National Average for interest deducted of $10,582, leaves $9,431 of the interest actually deductible. That works out to 89%, which is quite different from "it is possible" or "a minority of taxpayers".

Again, I don't think it's an appropriate label: "myth".

If someone is paying a mortgage, then they are most likely paying property taxes. If they are paying a mortgage, then they most likely have income that state taxes are paid on. If they are paying a mortgage, they likely make contributions to charity. Medical deductions, unfortunately, don't typically go over the threshold.
Paul
User avatar
paulob
 
Posts: 1408
Joined: Tue Feb 20, 2007 8:54 am

Postby paulob » Wed Jan 21, 2009 6:44 pm

nisiprius wrote:
plake15 wrote:The homeowner tax savings are so overstated by mortgage lenders and the industry in general because they know how easy it is to get an overwhelmed unknowledge buyer in it's pocket when they "show you the money you saved from going to Uncle sam" they will print out spreadsheets and have them to ready to go..But I have never seen one home lender have spreadsheet of the hundreds of thousands that you pay in interest over the life of the loan(even after the tax savings) that will go to some CEO retirement party in a decade or so..
I'm not sure what you're saying here. No, they don't show you how much you'll contribute to some CEO's retirement party, but I assume that you are still given the same kind of Truth-in-Lending statement I was given in 1976, which clearly spelled out the number of dollars of interest I would be paying.

That statement was relatively new in 1976, and it was noticeable that everybody at the table, including my own lawyer, hated to give it to me and were all chuckle-chuckle implying that it was some unimportant piece of arcana required by some silly government regulation, and I should really feel obliged to pay any attention to it. Obviously they were scared that if people knew how much a mortgage cost, they'd run screaming out of the room and back to their rental apartment.


I agree. Its been disclosed fully on every mortage I have been a party to.
Paul
User avatar
paulob
 
Posts: 1408
Joined: Tue Feb 20, 2007 8:54 am

Postby DSInvestor » Wed Jan 21, 2009 6:48 pm

plake15 wrote:But I have never seen one home lender have spreadsheet of the hundreds of thousands that you pay in interest over the life of the loan(even after the tax savings) that will go to some CEO retirement party in a decade or so..


I'm not one to defend the banks here.... but I have my mortgage with citimortgage and their web site has an option to generate amortization statement with the ability to enter parameters for additional principal monthly or as one time payment. This allowed me to model what would happen if I added $100, 200, 300, 400, 500 etc to every monthly payment. It was an eye opener to say the least. I settled on adding 500/month in principal to a base payment of 885 and I will greatly accelerate the payoff and save an immense amount of interest.

I'm no fan of giving all my money of to the government and I definitely don't want to contribute to CEO bonuses, so I pay it down faster. By accelerating the payments, I also won't need to refinance which would subject me to more fees, title searches, appraisals etc. I may reduce the mortgage interest deduction, but I'd rather pay less interest and contribute more to retirement plans. By contributing to retirement plans, I'm paying myself to get the deduction.
DSInvestor
 
Posts: 6536
Joined: Sat Oct 04, 2008 12:42 pm

Postby DiscoBunny1979 » Wed Jan 21, 2009 7:38 pm

DSInvestor wrote:
plake15 wrote:But I have never seen one home lender have spreadsheet of the hundreds of thousands that you pay in interest over the life of the loan(even after the tax savings) that will go to some CEO retirement party in a decade or so..

--------------

I have to disagree with this as well. When I bought my house, I was provided with a complete amoritization schedule that showed exactly how much was going to principle and interest with each monthly payment.
User avatar
DiscoBunny1979
 
Posts: 1953
Joined: Sun Oct 21, 2007 11:59 am

Re: Not all mortgage interest is tax deducti

Postby mptfan » Wed Jan 21, 2009 7:50 pm

paulob wrote:
mptfan wrote:Of course it is possible for someone to have sufficient other itemized deductions (other than the mortgage interest deduction) that add up to more than the standard deduction, so that all of the mortgage interest then becomes tax deductible. But this applies to a minority of taxpayers, and I suspect it is a relatively small minority at that.


I referenced Taxcut for a report showing IRS national averages for incomes of $50,000 - $99,999. The average National Average deduction excluding interest is $10,249. Subtract that from your cited 2009 std deduction of $11,400 leaves $1,151. If you subtract that from the National Average for interest deducted of $10,582, leaves $9,431 of the interest actually deductible. That works out to 89%, which is quite different from "it is possible" or "a minority of taxpayers".


Your analysis is flawed. The Taxcut data showing the average itemized deductions, by definition, only refers to those tax filers who itemize their deductions, and excludes those filers who do not itemize. Naturally, if you don't itemize, there is no way Taxcut would know how much you would have had in itemized deductions had you not taken the standard deduction. And since the majority of tax filers don't itemize, the "average" itemized deductions you cite are unreliable, and probably artificially high, and do not represent the average of all tax filers.

Second, the income range of $50k to $100k that you cited likely refers to Adusted Gross Income (AGI), and not total income. Someone with a 100k AGI has a total income of much more than 100k due to exemptions and deductions. A household that earns $55 to 60k (close to the average income) may have an AGI well below 50k.
Last edited by mptfan on Wed Jan 21, 2009 10:17 pm, edited 3 times in total.
mptfan
 
Posts: 3046
Joined: Mon Mar 05, 2007 10:58 am

Re: Not all mortgage interest is tax deducti

Postby mptfan » Wed Jan 21, 2009 7:53 pm

paulob wrote:If they are paying a mortgage, then they most likely have income that state taxes are paid on. If they are paying a mortgage, they likely make contributions to charity.


Those are some interesting and flawed assumptions. There are many people who have a mortgage, but do not pay state income taxes (including me). As far as assuming that people with mortgages also make charitable contributions, well, I don't know what to say to that. I guess you can assume anything you want, but you shouldn't expect others to accept your assumptions without offering some data to support it.
mptfan
 
Posts: 3046
Joined: Mon Mar 05, 2007 10:58 am

Postby Met Income » Wed Jan 21, 2009 8:12 pm

paulob wrote:
mptfan wrote:
paulob wrote:My itemized deductions for taxes is > than the standard deduction.

So, my interest is 100% deductible.


Your interest is only 100% deductible if your itemized deductions, excluding mortgage interest, is greater than the standard deduction.


That is what I said. The taxes I itemize, e.g. real estate, income, etc. are by themselves above the standard deduction. So, again, my interest is 100% deductible.


Your first post was not clear enough.

EDIT: I thought ID for taxes meant for your tax return
Last edited by Met Income on Wed Jan 21, 2009 8:20 pm, edited 2 times in total.
User avatar
Met Income
 
Posts: 970
Joined: Sat Feb 24, 2007 12:00 am

Postby Met Income » Wed Jan 21, 2009 8:17 pm

paulob wrote:
Enzo IX wrote:I think it also gets gradually phased out for the high income people.


Not phased out, just reduced.


It is phased out, which is also a reduction.
User avatar
Met Income
 
Posts: 970
Joined: Sat Feb 24, 2007 12:00 am

Postby Met Income » Wed Jan 21, 2009 8:19 pm

I have amortization software at my office. If anyone would like me to run different scenarios for them, let me know. It will only take a few seconds.
User avatar
Met Income
 
Posts: 970
Joined: Sat Feb 24, 2007 12:00 am

Postby DSInvestor » Wed Jan 21, 2009 8:30 pm

There are some mortgage calculators at

www.dinkytown.net
DSInvestor
 
Posts: 6536
Joined: Sat Oct 04, 2008 12:42 pm

Postby adam1712 » Wed Jan 21, 2009 10:01 pm

I find this a very interesting subject. To me, one of the big issues is the policy this sets. If you're a home builder, is there any doubt who you should be catering to? Building small, practical houses with small interest payments. Or larger houses where the people are effectively being given coupons to help buy the place because it helps lower their taxes.
adam1712
 
Posts: 191
Joined: Fri Jun 01, 2007 6:21 pm

Postby paulob » Wed Jan 21, 2009 10:01 pm

Met Income wrote:
paulob wrote:
Enzo IX wrote:I think it also gets gradually phased out for the high income people.


Not phased out, just reduced.


It is phased out, which is also a reduction.


If it is phased out, at what income level for a MFJ are itemized deductions reduced to zero?
Paul
User avatar
paulob
 
Posts: 1408
Joined: Tue Feb 20, 2007 8:54 am

Re: Not all mortgage interest is tax deducti

Postby paulob » Wed Jan 21, 2009 10:04 pm

mptfan wrote:Second, the income range of $50k to $100k that you cited likely refers to Adusted Gross Income (AGI), and not total income. Someone with a 100k AGI has a total income of much more than 100k due to exemptions and deductions. A household that earns $55 to 60k (close to the average income) would have an AGI well below 50k simply by taking the standard deduction and personal exemptions.


The data I cited is AGI and not income.
Paul
User avatar
paulob
 
Posts: 1408
Joined: Tue Feb 20, 2007 8:54 am

Postby GG » Wed Jan 21, 2009 10:29 pm

Good post

However, as most posts, its a generalization. When we bought our first home we were already donating about $10,000 per year to charity, yet with no other dedcutions we took the standard deduction. So we had zero tax break for our charitable deductions. When we were weighing the decision to rent or own, a major factor was the deductibility of interest and taxes because it was effectively 100% deductible since we neared the standard deduction with charitable gifts. I'll have to say that given the decision - though outlay is more - it sure is nice to have 40k or 50k in deductions!
GG
 
Posts: 447
Joined: Mon Nov 17, 2008 9:09 pm

Postby GG » Wed Jan 21, 2009 10:33 pm

paulob wrote:
Met Income wrote:
paulob wrote:
Enzo IX wrote:I think it also gets gradually phased out for the high income people.


Not phased out, just reduced.


It is phased out, which is also a reduction.


If it is phased out, at what income level for a MFJ are itemized deductions reduced to zero?


The phase out starts pretty low ($160k or so AGI - higher than me, so no comment on if that's low or high, but its not huge), but just google the issue and you will find various what-if calculators.
GG
 
Posts: 447
Joined: Mon Nov 17, 2008 9:09 pm

Postby Met Income » Wed Jan 21, 2009 10:49 pm

paulob wrote:
Met Income wrote:
paulob wrote:
Enzo IX wrote:I think it also gets gradually phased out for the high income people.


Not phased out, just reduced.


It is phased out, which is also a reduction.


If it is phased out, at what income level for a MFJ are itemized deductions reduced to zero?


Your deductions cannot be phased out to zero. I'm not sure of the specifics after that.
User avatar
Met Income
 
Posts: 970
Joined: Sat Feb 24, 2007 12:00 am

Re: Myth.... Not all mortgage interest is tax deducti

Postby grabiner » Wed Jan 21, 2009 10:57 pm

mptfan wrote:I hear variations on this myth repeated so often, without any qualification in the financial media. It takes various forms, but it usually goes something like this....

"If your mortgage interest rate is 6%, and you are in the 25% tax bracket, you are only paying 4.5% after taxes."

Well, this is simply not true for many people. The fact is that some people get no tax benefit at all for paying mortgage interest. And even those that do may only get a partial tax benefit.


This is an important principle, but not necessarily as relevant on the Bogleheads board.

Usually, it comes up on the Bogleheads board in the context of an investor deciding whether to pay down his mortgage. And in that situation, the 4.5% is correct even if he only deducts part of the interest, because a partial mortgage payment would reduce only the deductible portion of the mortgage interest. (Paying off the whole mortgage eliminates the non-deductible interest as well, so it has a better return than 4.5%, but few investors have that option unless they have a significant inheritance.)

According to the IRS, most taxpayers take the standard deduction (I think around 65% of all tax filers).


This is an overall average, but most taxpayers with mortgages do itemize deductions, since they pay mortgage interest and property taxes, and even more taxpayers who are considering paying down their mortgage itemize deductions, since they are usually fairly well off (with money to spare) and thus are likely to have other significant deductions such as state taxes, and can afford to make charitable contributions if they choose to do so.

(edited to fix quoting)
Last edited by grabiner on Fri Aug 06, 2010 8:46 pm, edited 1 time in total.
David Grabiner
User avatar
grabiner
Advisory Board
 
Posts: 13025
Joined: Wed Feb 21, 2007 12:58 am
Location: Columbia, MD

Postby plake15 » Thu Jan 22, 2009 12:15 am

The standard deduction in 2007(I'll use that year) was $5,350 for single filers, $7,850 for head of household, and $10,700 for married filers. The standard deduction is the "freebie" that all taxpayers can take without itemizing deductions. If you choose to itemize, as you must if you want to get the mortgage interest deduction, you can't take the standard deduction.

The total amount of deductions allowed can be limited by your income if you earned more than $150,500, or $75,250 (if married and filing separately).If your mortgage interest deduction and all your other Schedule A deductions (primarily state income tax, local taxes, auto excise tax and charity for most filers) is less than your standard deduction, you'd lose money if you itemized. Medical and dental expenses can't be taken unless they exceed 7.5% of your AGI (Adjusted Gross Income).

In most cases, it's during the early years of your mortgage when most of your payment is being applied to the interest,it probably will pay off to itemize. But the question really is how does the mortgage tax break changes your cost of ownership?.Let's say you're in the early years of paying down a $150,000 mortgage, 30 year term, 6.5% interest. The monthly payment is $948.10, so in the first few years of the mortgage, you're paying about $10,000 a year in interest. Lets also say your property tax is $2,000 a year, you gave $1000 to charity and paid another $2000 in other deductible taxes. How much have you increased your tax deduction by buying a house rather than renting? Well, there's the $10,000 in interest, plus the $1000 you gave to charity and the $2000 you spent on excise tax, state tax, whatever tax. I'm also giving credit for the $2,000 you're paying in property tax, but keep in mind that if you were renting, you wouldn't be paying property tax. That's a unique lovely privilege of ownership.So you have $15,000 in Schedule A deductions, versus the $5,350 you could have taken as the standard deduction for a single filer or the $10,7000 if filing as a married couple. In the single case, itemizing and taking the mortgage interest deduction has allowed you to reduce your taxable income by about $10,000, in the married case, you've been able to reduce your taxable income by about $5,000.

Now for the bad news. You haven't saved $5,000 or $10,000, you've only reduced your taxable income by that amount. This is where you have to be paying a lot of taxes already in order to save a lot of money. It's the same issue that comes up with buying tax free municipal bonds. If you are earning less than $30,650 as a single filer after deductions or less than $61,300 as a married couple after deductions, the most those deductions are saving you on your taxes is 15%. Our single filer who grosses up to around $40,000 a year and took out a $150,000 mortgage is seeing a tax benefit of about $1,500/year, and our married couple who grosses up to about $70,000/year with the deductions above is saving just $750/year on taxes - 15% of the $5000 of additional deduction. In both cases, the $2000 of property tax more than cancels out the "savings."

So who really are the big winners in the mortgage deduction game?other than the realtors who talk buyers off the fence by painting a glowing picture of tax savings.. High income individuals who give a lot of money to charity or pay a lot of local taxes are the main beneficiaries, especially if they have large mortgages on expensive properties..
plake15
 
Posts: 1043
Joined: Sat Oct 06, 2007 9:28 am

Postby thepommel » Thu Jan 22, 2009 1:11 am

Home interest deduction is not unlimited per tax law. You cannot deduct interest on a mortgage in excess of $1,000,000.

Regards,
thepommel
 
Posts: 333
Joined: Sun Jul 15, 2007 7:59 pm

Postby markh » Thu Jan 22, 2009 3:52 am

what if your self employed and in the highest federal and CA state brackets,
and if your mortgage is 750,000 on a property valued at 1.4 million (after the downturn). the rate is 5.25% so the payment is 4500, of which 3400 is interest, or 12 X 3400 = 40,800 interest annually. The property taxes are about 15,400.

so tax rate is 36+9+12.5

seems pretty sweet to me, and boy am I glad to have those deductions

mark
markh
 
Posts: 215
Joined: Sun Apr 22, 2007 8:13 pm

Postby Ted Valentine » Thu Jan 22, 2009 4:46 pm

DSInvestor wrote:
Ted Valentine wrote:The good side to not deducting mortgage interest is carrying less debt and most importantly sending less money to the bank!


Not deducting mortgage interest, by itself, has no affect on the amt of money you send to the bank and the amt of debt. However, if a homeowner realizes that they can't itemize and benefit from the mortgage interest deduction, it may make sense to send more money to the bank in the form of extra principal payments which in the long run will reduce the total interest paid the bank.


I was clumsy in my language. I should have said the good side to not being able to deduct mortgage interest is that you're probably carrying less debt and you're sending less interest to the bank.

For example, say Adam and Bart make the same amount of money and have the same exact tax situation. Only Adam owes $100k on his home and sends $6k to the bank in interest payments. Bart owes $400k and sends $24k to the bank in interest payments.

Adam gets no tax savings on his interest because his deductions do not exceed the standard deduction. Lets say that Bart gets the maximum tax savings of $6k on the $24k paid in interest based on his deductions.

One might say it is better to be Bart because he is not paying any taxes on that $24k of marginal income. Poor Adam takes the standard deduction and pays the IRS an extra $3375 taxes on his adjusted marginal $13.5k income.

Adam's total outlay is $9375 on the $24k marginal income. Bart's $24k income was all paid to the bank. In the end Bart feels good that he has a lower tax bill than Adam, but it doesn't feel as good as Adam who has $14,625 more on deposit at the bank.
Although our intellect always longs for clarity and certainty, our nature often finds uncertainty fascinating.
User avatar
Ted Valentine
 
Posts: 1540
Joined: Tue Jul 10, 2007 11:28 am
Location: Music City USA

Postby DSInvestor » Thu Jan 22, 2009 5:19 pm

Ted, Excellent point - great post. I would add that the difference in interest payments 18K per year is signficant and could severely affect an investors ability to save for retirement. This is one of the downsides of taking on large mortgages. That's more than a year of 401k contributions going the bank every year for many many years.
DSInvestor
 
Posts: 6536
Joined: Sat Oct 04, 2008 12:42 pm

Postby plake15 » Thu Jan 22, 2009 7:11 pm

Well like I said..someone needs to pay for that bank's CEO bonus..or even more so that big retirement party the CEO is planning in 10 years..

Someones got to shell out that several hundred thousand in mortgage interest to the bank if that party is to happen :) Banks are for profit..They are in it to make money first and foremost,they don't give mortgages out of the kindess of their heart..If you default see how fast they could care less..that foreclosure and/or penalty notice come quite fast..
plake15
 
Posts: 1043
Joined: Sat Oct 06, 2007 9:28 am

Re: Myth.... Not all mortgage interest is tax deducti

Postby stratton » Thu Jan 22, 2009 7:21 pm

mptfan wrote:I hear variations on this myth repeated so often, without any qualification in the financial media. It takes various forms, but it usually goes something like this....

"If your mortgage interest rate is 6%, and you are in the 25% tax bracket, you are only paying 4.5% after taxes."

Well, this is simply not true for many people.
The fact is that some people get no tax benefit at all for paying mortgage interest. And even those that do may only get a partial tax benefit. This is because every taxpayer can choose between itemizing their deductions or claiming the standard deduction, and you can claim the standard deduction regardless of whether you qualify for any itemized tax deductions. According to the IRS, most taxpayers take the standard deduction (I think around 65% of all tax filers). So, most people do not get the benefit of the mortgage interest tax deduction, and even those that do only benefit to the extent that the total of itemized deductions exceeds the standard deduction..

Devil's advocate time!

Your whole post is a myth without any examples from "the media". :P

The original post engages in the same behavior "the media" is accused of.

Paul
User avatar
stratton
 
Posts: 10789
Joined: Sun Mar 04, 2007 6:05 pm
Location: Puget Sound

Postby overpar » Thu Jan 22, 2009 10:24 pm

There are other mortgage interest limits in addition to the standard vs itemized issue. It must be "qualified residence interest" that can place limits on loans of $1 mil+, and also on cash-out refis where the proceeds are not used for home improvements. Also, if you're an AMT payer, there are more limits
overpar
 
Posts: 72
Joined: Sat Mar 29, 2008 1:44 pm

Postby On Approach » Thu Jan 22, 2009 10:43 pm

what if your self employed and in the highest federal and CA state brackets, and if your mortgage is 750,000 on a property valued at 1.4 million (after the downturn). the rate is 5.25% so the payment is 4500, of which 3400 is interest, or 12 X 3400 = 40,800 interest annually. The property taxes are about 15,400.


On the other hand, how about a married resident of Nevada, no state income tax, property taxes of $1,200, $305,000 30-year mortgage at 5.375% on a $380,000 property (interest of ~$14,000/year), sales tax deduction of ~$2,000, and very few other itemized deductions (~$200). Amount of mortgage interest deductible is only ~$6,500 (less than half of the mortgage interest). That's only 16% of the CA resident's deductible mortgage interest.

A much more compelling argument for the Nevada homeowner to pay off the mortgage quickly, even with the 5.375% rate.
On Approach
 
Posts: 437
Joined: Fri Aug 22, 2008 11:11 am

Re: Not all mortgage interest is tax deducti

Postby nisiprius » Fri Jan 23, 2009 6:10 pm

stratton wrote:Your whole post is a myth without any examples from "the media".
The media constantly mentions mortgage interest deductions without mentioning that you don't get any benefit unless your financial situation makes it advantageous to itemize. mptfan states the myth thus:
mptfan wrote:... it usually goes something like this...."If your mortgage interest rate is 6%, and you are in the 25% tax bracket, you are only paying 4.5% after taxes."
Well, take a look at how SmartMoney.com puts it:
You've heard again and again how buying a home is the best tax break around. Maybe you've even been called a chump for renting. After all, paying $1,200 a month for your mortgage is really the equivalent of paying $900 a month in rent. But how does that work exactly? Here's the deal: Mortgage interest (including points)and real estate taxes are tax deductible. That doesn't sound very sexy, but it adds up. Since most of what you pay for your mortgage in the first years is interest, on a $1,200 mortgage payment you get to deduct about $1,080 a month.--smartmoney.com, March 21, 2008
Isn't that similar to mptfan's statement of the myth? Here is an even closer one:
[Determine your tax bracket, etc.] Subtract that number from 100 (100 - 21 = 79, in our example). Multiply that number by your mortgage interest rate (79 * 6%, let's say). The result is your effective mortgage interest rate after the tax deduction (4.74% in our example).--The Cheap Bastard's Guide to the Good House + Home, 2007
Here are some others:
There are other tax savings around the home that you can pick up. The tax laws encourage home ownership by making mortgage interest and local property taxes deductible for federal tax purposes.--Popular Mechanics, Jan 1960
The right mortgage can save you tens of thousands of dollars. To be sure, the interest is deductible from your taxable income. But the topmost income tax bracket, starting next year, is 28 percent.--Cincinnati Magazine, Oct. 1987
Uncle Sam is standing by to serve as a generous partner in your investment.... The opportunity to trade nondeductible rent payments for mostly-deductible mortgage payments is a powerful lure enticing you from your rental abode into a home of your own.Kiplinger's Buying and Selling a Home, 2006
According to the tax laws in effect during the writing of this book, you can also deduct the mortgage interest you pay on a loan of up to $1,000,000 on your first or second homes. In effect, unless you neighbor with royalty, all or most of the mortgage interest on your first or second homes is deductible.Flipping Houses for Dummies,2006
In addition to building equity, there are tax advantages. Depending on your tax bracket, owning a home is often less expensive than renting, after taxes. Interest payments on a mortgage below $1 million are tax-deductible. A mortgage consultant can help you evaluate the tax advantages of various loan scenarios, then share this information with your tax consultant to glean feedback.--The Sun. Lowell, Mass.: Jan 19, 2007
Another disadvantage to an early mortgage release is lost tax savings. The interest on a mortgage is tax-deductible and often translates into considerable annual savings for homeowners. In a nutshell, no mortgage, no related tax savings.--The Patriot Ledger. Quincy, Mass.: Jul 7, 2007. pg. 30
"A little year-end attention to your mortgage bill could lower what you'll owe Uncle Sam at tax time. That 's because you can often vary when exactly the bank gets your mortgage payment due Jan.1 - impacting whether one month of deductible mortgage interest goes on your 2005 or 2006 tax return. --Boston Herald. Boston, Mass.: Dec 16, 2005. pg. 055
For the ones with links, check the context for yourself. Many of these think it's important to warn you that that only the interest on the first $1,000,000 (!) of the mortgageis deductible. Yet not one of them mentions the possibility that you are not itemizing. Not one! Unless you count one that says something vaguely about contacting your tax advisor for details.

I think there's a triple explanation. First, mindless repetition of propaganda from the real estate industry and mortgage sellers. Second, an unstated assumption that you're in the upper-income category (shown by the fact that they so often think you need to know about the million-dollar limit!) Third, perhaps, a careful writer checking the tax code will look closely at the law and limits of what is deductible, and state (correctly) that it is deductible, while allowing you to infer that "deductible" means "tax savings."

P. S. I know this will sound incredible, but in my personal experience there are an astonishing number of financially unsophisticated people who think that a deduction is the same thing as a tax credit, i.e. they think the "deductions" are subtracted from their taxes, not from their taxable income.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.
User avatar
nisiprius
Advisory Board
 
Posts: 25278
Joined: Thu Jul 26, 2007 10:33 am
Location: The terrestrial, globular, planetary hunk of matter, flattened at the poles, is my abode.--O. Henry

Postby jh » Fri Jan 23, 2009 8:36 pm

...
Last edited by jh on Wed Jan 28, 2009 11:42 am, edited 1 time in total.
jh
 
Posts: 1769
Joined: Mon May 14, 2007 12:36 pm

Postby DSInvestor » Fri Jan 23, 2009 8:58 pm

jh wrote:Being a long time renter I often find "home owners" have an irresistible urge to tell me how I am throwing my money away paying rent. They will usually bring up the tax benefit.

I just play a long with it and tell them that they are a financial genius for buying a house, which is exactly what they want to hear. In my head though I am laughing at the moron because I know he is probably using standard deduction. :lol:


There's no clear cut answer to renting vs owning.
-Renters who do not save aren't doing themselves any favors. Those that are able to save for retirement and other needs will probably do just fine, plus they have the flexibility to pick up and move.

-Homeowners who paid too much, borrowed too much, picked the wrong mortgage or tapped too much equity could be in trouble. On the other hand, home owners who bought at a reasonable price, who are able to save, pay down their mortgages and see some price appreciation are probably sitting happy.

I suspect that with home values falling and many folks underwater, there aren't as many people questioning your decision to rent.
DSInvestor
 
Posts: 6536
Joined: Sat Oct 04, 2008 12:42 pm

Postby stratton » Fri Jan 23, 2009 9:05 pm

jh wrote:Being a long time renter I often find "home owners" have an irresistible urge to tell me how I am throwing my money away paying rent. They will usually bring up the tax benefit.

I just play a long with it and tell them that they are a financial genius for buying a house, which is exactly what they want to hear. In my head though I am laughing at the moron because I know he is probably using standard deduction. :lol:

One benefit of having a payed off home or fixed rate mortgage is you know how much your going to pay each month in shelter expenses. This can be a heck of an inflation fighter and lend a huge amount of stability when calculating how much you need to live on. This can be pretty important to someone retired.

Conversely it can be a ball & chain if you need to move some place else to get work.

Paul
User avatar
stratton
 
Posts: 10789
Joined: Sun Mar 04, 2007 6:05 pm
Location: Puget Sound

Next

Return to Investing - Theory, News & General

Who is online

Users browsing this forum: bhsince87, bling, D.Edelstein, FAST Enterprise [Crawler], frugal-dave, greenfire, MnD, packer16, Park, ProdigalSon, Random Walker, RunningRad, tecmage and 64 guests