A Meltdown for the "McMansion"?

I noticed an interesting article in Saturday's edition of the Arizona Daily Star and I felt the need to investigate. A committee leader in the House of Representatives has proposed that mortgage interest deductions be taken away for homes larger then 3000 square feet. Republican John D. Dingell, in charge of the House Energy and Commerce Committee, is drafting a "carbon tax" legislation that would deny homeowners these write offs. The reasoning behind this is that large homes, or "McMansions" consume larger amounts of energy (electricity, heating, air conditioning, construction materials etc) then smaller homes and by eliminating the deduction there will be less demand for these McMansions, in turn reducing carbon emissions.

Needless to say that this proposed legislation is causing quite a stir in the real estate world. This possible legislation is being announced at a time when some consumers are already leery of buying a home due to instability of the mortgage industry and the economy in general. The mortgage interest rate tax deduction has always been a great incentive for consumers to invest in a home, whether it be their first home or upgrading to a larger one. Eliminating the deduction will cause chaos for buyers and sellers alike. The National Association of Realtors estimates that terminating this tax deduction will result in a 4% decline in the national median house price of all homes and potentially increase the rate of foreclosures in a market that is already saturated. But this legislation will also have a strong impact on the rental market. Since market forces drive the prices of rental homes as well and owned homes, ending the tax deduction will change the prices of all housing.

As we all know, the impact of this legislation if passed, will vary among families. We assume that most homeowners already know about the Mortgage Interest Deduction (MID), and that they itemize their tax returns in order to get it. But how many homeowners actually take advantage of this benefit? I found some interesting information regarding this from the Joint Tax Committee. Below is a chart that provides data on exactly who takes advantage of the MID.

Benefits of the Mortgage Interest Deduction

The first column shows the fraction of itemized tax returns arranged by income group. Those in the lower bracket itemize very little while those in the higher itemize almost 94% of the time. The second column shows the fraction that use the Mortgage Interest Deduction benefit. Makes sense; if you don't itemize then you can't use the MID. The third column shows taxpayers' savings by group, as a result of the mortgage tax deduction, and the last column shows what percent of the taxpayers' total savings can be attributed to each group. Easy to see that those in the higher income bracket (and most likely the owners of bigger homes) will be effected the most by a termination of the Mortgage Interest Rate Deduction. Or will they? When you look at the following chart, you'll see that those homeowners in the higher bracket attribute less of their wealth to their primary residence.

Home Ownership and Wealth

When reviewing both charts it's interesting to see that though most of the of wealth for the lower bracket is in the form of housing, the Mortgage Interest Deduction is rarely used. It seems that those in the higher brackets attribute their wealth to areas other then their homes, which can leave them less effected by this potential tax change.

It will be interesting to see if the carbon tax legislation ever makes it passed the proposal stage. Similar proposals has been made in the past but never brought about because the deduction is so popular with taxpayers and it has strong support from the real estate, banking and construction industries. In the meantime I myself won't get too upset. We will most likely see nothing come out of this; the story will disappear (hopefully) into the recycle bin with the rest of last weeks news headlines. Just one more temporary stressor in the real estate world!