President Obama's Defecit Reduction Panel recommended eliminating the mortgage interest deduction for all properties other than primary residences of $500,000 or less.
While this seems like a good way to raise immediate tax revenue, I question whether the Panel thought through all of the implications of such an action.
My question is what would the impact be on the value of non-primary residence property values. Right now investment property owners utilize the mortgage interest deduction as a business expense.
For instance, say you purchase a 4 unit apartment building in Burlington for $400,000. You make a downpayment of $100,000 and borrow $300,000 from a bank for 30 years at 5%. Your montly mortgage payment would $1,610. The interest portion of your payment in the first year would be approximately $1,250. Thus, the interest expense in the first year of business would be $15,000.
Say you take in rents (gross revenue) of $40,000. Say your taxes and other expenses are $16,000. Your net operating income before loan payments (i.e. debt service) is $24,000. After deducting the mortgage interest as an expense your taxable income from the property is $9,000. Thus, you are making about a 9% return on your $100,000 and paying taxes accordingly.
Now lets assume you cannot deduct the interest as a business expense. You would have taxable income of $24,000 but only pocketing $9,000. Your return has now been diminished significantly due to the taxes due on the $24,000.
If your return is diminished then the price you are willing to pay will also be lower. The $400,000 purchase price might now be $375,000 or less so that you can make a comparable return.
If property values fall as a result of this tax change then revenues from Capital Gains taxes will also fall on investment properties. It would seem possible to me that any increase in revenues from the elimination from the tax deduction could be offset by the harm that lower property values does to our economy.