Will Mortgage Deduction Survive Fiscal Cliff?

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The deduction can only help those families who choose to itemize their tax returns, which middle class home buyers often don't do. The wealthier often happen to be those who are shrewder about their taxes, who make sure to claim the deduction, and it's also frequently part of the pitch the realtor gives them in order to get buyers into a higher priced home. The interest deduction not only covers mortgages on primary residences, but also on second homes. The deduction can go up to $1 million for married couples, more than most families' mortgages.

"This is not about starter homes," Kleinbard said. "We are not talking about taking that first step on the real estate escalator which was the way we all looked at home ownership … tax benefits like the home mortgage interest deduction, it's not free money. It's a government subsidy by another name, so you have to ask, Are we getting the best value for the subsidy for this mechanism because it is a very expensive subsidy and the answer is no. What we end up doing is subsidizing upper income Americans buying bigger homes than they otherwise would and that is not sensible national housing policy."

But, what about first-time buyers like Picarillo, who credits the deduction with allowing her to buy her first home because she lives in an area that is more expensive than other areas of the country?

"Federal tax policy has to deal with the nation as a whole," Kleinbard said. "We don't have different tax rates for different people. Just because there is a higher cost of living in New York there can't be a different tax rate schedule than people living in Missouri."

Kleinbard says the income tax structure may "hurt people who live in high cost of living areas," but "that's your choice."

"And your wages presumably reflect that higher cost of living and that's why you are willing to take the trade off, but the United States tax policy can only have policy for the entire nation," Kleinbard said.

He added that he lives in Los Angeles where home prices are also sky-high and the elimination of the deduction would hurt him personally, but "we need the money. How are we going to get the money?"

"From the point of view of the federal tax policy, there is one policy for the whole country," Kleinbard said. "Is this a useful way to be spending money we don't have to raise taxes on all Americans somewhere else?"

For those who want to protect the deduction like Picarillo and her mother, Debra Gailhard, also a realtor with Waterfront and Estate Properties in Connecticut, say it could have serious reverberations on a housing market that is already struggling to rebound. Gailhard said she counsels young buyers to stop renting and buy because of the break.

"That young bunch, they go to their mother and father and say, 'Hey is this a good investment? Buying a house?' And mothers and fathers say, 'Yes, you get an immediate write off on your taxes ... it's better than renting,'" Gailhard said, adding she's afraid if it were eliminated it could "affect the whole industry."

"We are just climbing out of our hole," Gailhard said. "If the housing market continues to be robust it keeps people working … but if this is just the little catalyst that turns [the housing market] down our whole economy is affected."

Connie Trolle, a realtor with Litchfield Hills Properties in Litchfield, Ct., an area where many people are buying second homes, says it may be the wealthy taking advantage of the deduction, but those are the same people who are stimulating the economy. Referring to a customer of hers who bought a $4 million home and will take advantage of the break, she said, "It's certainly stimulating the economy here. He remodeled the house and kept people working."

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