A Radical New Proposal for the Mortgage Interest Tax Deduction

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UNITED STATES - NOVEMBER 30: Rep. Keith Ellison, D-Minn., is interviewed in his Longworth office about his Muslim faith. (Photo By Tom Williams/CQ Roll Call)
Tom Williams/CQ Roll Call Rep. Keith Ellison (D-Minn.)
U.S. Rep. Keith Ellison has a game-changing tax fix that he think most Americans would happily get behind.

Ellison, the Democrat who represents Minnesota's 5th Congressional District, just proposed a bill that would revise the federal tax code, radically changing the way America's mortgage-interest deduction works.

Where you fall on the income scale will likely determine how you feel about Ellison's idea as proposed in The Common Sense Housing Investment Act.

Mortgage Interest Deduction Math

Right now, anyone with a home mortgage can write off the interest they pay on their federal income taxes. The calculation is simple: The amount you paid in interest for that year is subtracted from your income.

This is a big deal for many taxpayers. One estimate from The Wall Street Journal puts total federal tax savings at $100 billion a year. It's also a big deal to real estate agents and banks, as the tax write-off can be a major selling point for homes and home loans.

But to utilize the mortgage-interest deduction, you have to itemize your taxes, which not everyone can do. Enter Rep. Ellison and his Common Sense Housing Investment Act. His bill would open the mortgage-interest deduction to more taxpayers by changing how they claim it. Rather than taking whatever they paid in interest off their income, now homeowners would claim a standard 15 percent tax credit.

Under the Common Sense Housing Investment Act, the number of Americans able to claim the mortgage-interest deduction would jump from the current 43 million to 60 million.

Everyone Wins! Well, Almost Everyone

Perhaps the most interesting trick here is that the bill would allow more homeowners to claim a mortgage-interest deduction on their federal income taxes, but also allow more total tax revenue to be raised.

Ellison's plan would allow people to only deduct interest on mortgages up $500,000; after the half-million dollar mark, they couldn't deduct any mortgage interest whatsoever. According to Ellison, however, only 4 percent of homes nationwide sell for more than half a million dollars. So in the end, far more middle-class homeowners would be able to write off their mortgage interest, while the well-to-do would lose the tax break.

According to Ellison's calculations, his plan would generate an additional $196 billion in revenue over 10 years -- money he would earmark toward addressing what he calls a "national rental shortage" -- which mainly affects minorities, the elderly, and the poor -- by expanding the Low Income Housing Tax Credit and Section 8 rental assistance.

A Tempting Tax Target

The mortgage-interest deduction comes under attack every once in a while for different reasons.

In the wake of the financial crash, it was called out as a contributing factor in that it helped feed the general mentality that everyone should own a home, which in turn propelled us into the housing boom and bust. The mortgage-interest deduction has also been called out as a debt and deficit expander, because it causes the government to miss out on a lot of tax revenue.
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Then there's the free-market economics argument that claims the mortgage-interest deduction is a market distorter. There's no logical reason the federal government should give homeowners the ability to write off their interest on a large purchase. Why don't car owners get to write off their car-loan interest, or boat owners their boat-loan interest?

In his documentary "The Ascent of Money," historian Niall Ferguson claims the federal government made the move to create a large class of property owners in the 1930s -- specifically, with the creation of the Federal Housing Administration -- in part as an effort to blunt the rise of communism and socialism in America.

But however you want to look at the issue, the bottom line is that it was decided a long time ago in this country to promote home ownership, and Americans are used to it. The real-estate and banking sectors don't want to see the deduction go anywhere, either.

So if the mortgage-interest deduction is here to stay, sure, why not open it up to more of the middle class? And then you can use the projected proceeds to help the less fortunate.

Most would see this as a win-win, probably except for the people at the top who have to pay for it.

John Grgurich is a regular contributor to The Motley Fool. Follow his dispatches from the bleeding heart of capitalism on Twitter @TMFGrgurich.

10 PHOTOS
Breast Implant Write-Off? Outrageous Tax Deductions
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A Radical New Proposal for the Mortgage Interest Tax Deduction

Up first is the case of exotic dancer Chesty Love, who in 1988, at the urging of her agent, "underwent multiple medical procedures to replace and to substantially enlarge her [breast] implants," according to TaxProf Blog. In a sense, the plan worked: Love's earnings almost doubled after the surgeries. But her bosom had become so large -- size 56FF -- that she suffered unspecified medical problems, as well as "considerable humiliation." According to a tax court opinion,

Petitioner was ridiculed by people on the street, her husband suffered off-color comments and insults, and she was ostracized by most of her family. Consequently, when her career as a professional exotic dancer is over, petitioner plans to have the implants permanently removed.


Since the expense of Love's plastic surgery was "incurred solely in the furtherance of the business engaged in" and "incurred in producing revenues to the business", the court found that she should indeed be allowed to depreciate the cost of her implants (Hess v. Commissioner, 1994). 

Photo: YouTube.com

The owners of a dairy business went on an African safari and tried to write the cost off as a business expense. They justified the deduction by saying that many of the dairy's promotional activities and marketing efforts included wild animals.

We're not sure that "wild dairy cows" exist, but the IRS agreed that the trip was "ordinary and necessary" and allowed the deduction.

A gas station owner who gave his customers free beer tried to write it off as a business expense.
He ended up in tax court, but the final ruling came down in his favor and upheld the deduction.

Interestingly, an Oklahoma businessman tried to deduct several cases of whiskey that he gave to his clients as "entertainment." That deduction, however, was flatly denied.
 

A Pittsburgh furniture store owner had tried to sell his business for years, but there weren't any takers. Frustrated by his lack of success, he hired someone to burn the store down. He collected $500,000 from the insurance company for his misguided effort.

Brazenly, the man went on to deduct the $10,000 that he paid the arsonist as a "consulting fee." An IRS audit two years later ended with both men in prison.
 

A doctor told his emphysema patient that the sick man needed to start exercising. The patient decided to install a swimming pool at his home, and then he deducted the cost as a "necessary medical expense."

The IRS agreed with the deduction -- not only for the pool, but also for the costs of the various chemicals, cleaning, heating and upkeep. No word on whether he could write off his suntan lotion.

While the IRS looks favorably upon swimming pools, it doesn't look as  kindly on dancing.

Thinking that learning how to dance would improve her varicose veins, a taxpayer tried to deduct the cost of her dance lessons. The government cut in, declaring that the dancing was "not medically necessary."

There are about 75 million household dogs in the U.S. That means millions of pooches are left at home alone each day. To ease his pup's unhappiness, one taxpayer hired somebody to come to his home and watch his dog while he went off to work.

The IRS howled, however, when the taxpayer tried to deduct the cost by using a day-care tax credit intended for children and legal dependents. Pets do not qualify.

Some junkyard owners had finally had enough of a nasty snake and rat problem, so they cleverly set out bowls of pet food each night to attract wild felines. The cats not only ate the pet food, they also took care of the junkyard's unwanted guests.

Because the cats made the business safer for customers, the pet food was deductible as a business expense. Let's just call it a purr-fect solution.

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