Sandwich Generation's Mortgage-Deduction Debate
As Washington considers cutting the popular write-off, some family members may have more to lose than others
Jeff Brown has nearly 20 years experience as a personal finance columnist for publications including The New York Times, The Nightly Business Report on PBS, The Philadelphia Inquirer and MSNBC.com.
Of all the subjects that ought to be dull as dishwater but aren’t, the mortgage-interest deduction may top the list. To its supporters, this write-off is right up there with Mom and apple pie, a basic entitlement that helps make homes more affordable by allowing you to deduct mortgage interest on your tax returns. Detractors say it’s nothing more than a blatant transfer of wealth from renters and the poor to the well-to-do.
Now the mortgage-interest deduction may be in jeopardy, as Congress and the White House ponder ways to cut the federal deficit and avoid the “fiscal cliff.”
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The deduction, which the U.S. Treasury says would reduce federal tax revenue by more than $100 billion in 2013, seems likely to survive in some form. But it may well be trimmed or capped, which could affect each age group of a Sandwich Generation family in very different ways.
How the Mortgage Write-Off May Change
Among the leading proposals on the table:
- Limiting the deduction to interest paid on mortgages of up to $500,000, down from the current $1 million on first and second homes. (To claim the deduction this year, you must itemize write-offs of at least $5,950 if you're single or $11,900 for married couples filing a joint return.)
- Eliminating the deduction for second homes.
- Capping all write-offs, including mortgage interest, at $25,000 for high-income taxpayers.
Here’s how the current scenario plays out in our Sandwich Generation family: My 80-something mom and 60-something sister have paid off their home loans, so they have no mortgage interest to claim. My wife and I have paid our mortgage down to next to nothing and therefore claim a very small deduction. Our son and my sister’s two boys are likely to be renters for quite a few years, so all this talk about mortgage interest is a yawn to them.
Who Benefits Most and Least
There’s no question that some homeowners now benefit far more than others, especially the wealthy, who tend to have the biggest mortgages and are in the highest tax brackets. Someone in the 35 percent bracket who pays $10,000 in mortgage interest would get a $3,500 write-off, while someone in the 15 percent bracket would save just $1,500.
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The benefit is also valuable to those who have many years left on their home loans and enough write-offs to itemize on their tax returns.
In the early years of a mortgage, nearly the entire monthly payment goes toward interest, so practically every dollar is tax deductible. But as the years pass, the interest portion of the monthly payment shrinks and the principal rises. A homeowner with a $200,000, 30-year mortgage at 3.5% would pay about $6,900 in interest the first year, $4,500 in the 15th year and just $200 in the 30th.
That interest/principal seesaw is why the youngest adults in Sandwich Generation families often stand to gain the most from the deduction — most likely they’re in the early years of a mortgage. (The exception to this rule: If their mortgage interest and other deductions don’t exceed the standard deduction, they cannot write off the interest.)
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Parents in their 40s, 50s or early 60s might reap a much smaller benefit. Not only are they further along on their mortgage, they might have bought their homes 15 or 20 years ago when prices were much lower. So their overall debt, including interest, is smaller.
However, Mom and Dad could claim a sizable deduction if they took out or refinanced a mortgage in the past few years. The value of their write-off could also be substantial if they’re in their peak earning years and paying steep tax rates.
The oldest Sandwich Generation members — grandparents — are the least likely to benefit since they've probably paid off their mortgages.
Mortgage-Interest Tax Savings by Age
Economists Todd Sinai of the Wharton School at the University of Pennsylvania and James Poterba of the Massachusetts Institute of Technology analyzed the mortgage deduction’s tax savings for homeowners who itemized in 2004 (a year not too different from 2012) and found striking differences by age. Homeowners 25 to 35 saved $1,155 and those 35 to 50 saved a little more: $1,598. But the savings fell to $1,226 for taxpayers 50 to 65 and just $149 for those over 65.
One reason for the puny tax savings for senior homeowners: Less than 23 percent of them itemized. In the other age groups, that number jumps to between 71 and 83 percent.
A Topic for a Family Discussion
While your family hashes out who benefits most from the mortgage-interest deduction, you may also want to ponder some fairness issues. Should renters subsidize homeowners, as they do now? Do affluent taxpayers deserve to reap the biggest mortgage write-offs? Should the general public, in effect, be chipping in to help the wealthiest Americans buy luxury homes?
Food for thought around the family dinner table, no?