patrick.net

All things being equal, the mortgage deduction would certainly be a factor in the rent/buy calculation.

But, as has been eloquently pointed out many times on this and other fora, all things are currently NOT equal.

I think the mortgage deduction for OO's in the US plays the same part as the building depreciation allowance for RE investors in Australia. It is a selling point for the Realtor (tm) to trot out.

For any newcomers, you can use this spreadsheet model I created with the help of lots of smart folks from this blog. It'll show you exactly what the tax-deduction is worth to you financially.

Bottom line is the tax deduction is powerful, and good, but it doesn't overcome dramatically overpriced houses.

Investors in Oz get numerous tax breaks, and nothing much on owner-occupying, so the position is more or less reversed from the US one. However, we are seeing similar rates of investment purchasing, e.g. 40% of new mortgages have been for an investment property in both countries in recent times (altho that could be changing as the bubble bursts and ROI diminishes, which even the dummies who just attended a RE seminar can now see).

There's no Prop 13 in other bubble centres, both nationally and internationally, e.g. NYC and DC.

This might mean that other factors are equally to blame -- historically low interest rates, a shaky sharemarket post-Enron, WorldCom and dotcom, and much more liberal lending products from the banks, with a transformed 'acceptable risk' profile. (We are now beginning to see the fallout from the new acceptable risk products from the banks...)

Sharemarkets are recovering and confidence in stocks is increasing. Property ROI is mined out for another 10 years. The Juglar business cycle is turning another notch...

The psychological perception of tax benefit is just too powerful.

These two statements are the same. But they will be perceived very differently:

1. Not paying mortgage interest and not having to deduct tax.
1. Not paying mortgage interest and missing out on deducting tax.

House prices are higher in blue states than in red states.
So, the power of the mortgage deduction is higher in the blue states.
In a sense, where the mortgage deduction mitigates a blue stater's housing cost, it is a kind of a subsidy from the red state folks.

A cap on the mortgage deduction would be more fair to the red state people. But since the Republicans who pander to people in the red states are wealthy elites, they wouldn't dare stoke a fire of resentment in their home turf. So we in the blue states benefit in a trickle down effect.

hmm, well, it's certainly an interesting picture... "Run away! Run away!"

regarding the 250K (500K for a couple) discount, "how do you know if it's your primary residence"? Easy, it's the one you're selling.

I don’t understand why so many people treat the tax deduction like it’s the best thing since sliced bread. After all, you can only deduct money that you spend. That’s money you don’t have for other things like an emergency fund, your kid’s braces, etc.

Well, it does cancel out the property tax that so many of us always bring up...

Oz OOs get a bigger tax break than the US when they sell, the gains from primary residence is NOT taxed at all. Of course, you get no deductions if you sell at a loss. How to determine primary residence? Any homes that you lived in for the last 6 years and rented out for less than 6 months (ajh and DS, correct me if I'm wrong). If you rent out for more than 2 years in the last 6 years, cap gains are calculated pro rata. So theoretically, I can move into one home every 6 years in Oz and reap all the gains tax free.

In the US, if you live for 2 years out of the last 5, you can claim that home as one of your main residences (up to two), and get that $250K pp, $500K per couple tax deduction. So theoretically, you can move every 2 years and pocket your gains $500K tax free.

Oz encourages property speculation far more than the US. Prop 13 is unusual and confined to California, Oz land tax is a joke. You know how much it is for a million-AUD property in QLD, for example? Around $2500 AUD a year, that's it. I don't know how they assess it, but the tax % of the property is so low that the hike in value won't lead to a big jump in annual holding cost of property tax. Then, the council rate is about $1200-1500, so the total holding cost is south of $5K even for high end properties.

Therefore, although Australia taxes heavily on income, and investment gains, holding property in Oz for long-term gains is very cheap. Those in the highest bracket of 48.5% typically buy negative gearing (slightly negative cash flow) properties to lower their income tax while waiting for appreciation.

This whole negative gearing thingy has just as much of a psychological impact as the mortgage interest deduction. You really have to run the numbers to understand if it works for your scenario. With the exception of those who have most of their income locked in the 48.5% tax bracket and confident of property appreciation, the tax benefit is offset by the negative cashflow one has to sustain throughout the lifetime of the property. If your cashflow is positive, then no negative gearing tax benefit can be reaped.

AMT is a complicated bitch. You CAN deduct mortgage interest but NOT property tax. Property tax for a typical million-dollar home in CA is $10K, while the annual interest on a typical loan for that million-dollar home is around $50K, so you see AMT doesn't dilute the tax benefits so much.

If you folks want to see something curious, check out this realtor's site:

http://www.erinna.com/mylisting.php?q=1

I like how some of the properties call out that they were "sold over asking".

The IRS code should have worked the other way around, discouraging property speculation in the US.

Prior to the 97 tax law change, one had to roll all the gains up into a more expensive home within a year of selling his old home, or the gain on his home would be taxed as capital gains. The 97 change made it possible for people to bubble sit, such as Herr Randy, because he got to keep all his $500K gain tax free while waiting on the side line. Plus, lots of flippers are flipping their properties within 1 year, so they are not even taking advantage of the 2-year residency that is mandatory for the $500K cap per couple, nor are they taking advantage of the capital gains tax treatment which requires them to hold their property for at least 12 months.

Therefore, I think the IRS codes have less to blame than the historical low rates and the extremely loose lending policy. If everyone had to borrow money the way that I borrowed back in 94, Bay Area property value would have to crash at least 30% if not more.

NY City expert requested

http://www.mlslirealtor.com/unidetails.cfm?mlnum=1873210&PFormat=1&typeprop=1

This is a house in Little Neck, Queens for $775k. Why is the property tax only $1,444 a year? In fact, property tax for most properties in Queens are really low.

Across the border in Nassau, it's easily $10k a year.

As my father once told me, “You don’t get rich spending a dollar to save 30 cents.”

It's just like buying google shares at $200, and the whole P/E disaster of the dotcom era -- you buy a stock for its perceived capital gain value, not for its dividend. In the case of Oz, investors can write off any losses on investment property against personal income, and thus could get up to a 50% refund from the govt at tax time. A refund for speculating at a loss. They also halved the capital gains tax on the sale of investment property. These things prompted RE gurus/spruikers to encourage people to buy loss-making properties in the belief that the inevitable "conservative" 10% growth a year would put them into positive cash flow territory in, ooh, say 10 or 20 years. Meanwhile, the govt will be equal partners in your loss! The taxman is paying for your property! Isn't life great? So these guys were making a loss to get ahead, in their estimation. It *can* work in that the dollar will inevitably be devalued over 20 years, so a large mortgage now may look like a small mortgage in 20 years time.

However, the price of properties may well collapse, since it's travelling at 200% of historical norm, and since they pushed up the income tax threshholds, most people will now most likely only get 33% back at most. These things have served to cool the market a little. Finally, the Treasurer has relented from his bubble-pumping habits of the past and has done a couple of tweaks to encourage more investment in shares and less in property as boomers approach retirement...

OO,

It's actually more generous than you describe, or at least it used to be.

After you establish a primary residence by 6 month's occupation, you can then have as many under-2-year rental periods as you like as long as you move back in (for at least 6 months, I think) between each rental period.

However, you can only have one primary residence at any one time, so you can't cycle between 3 or 4 houses and progressively claim them all as 'primary' when selling. (Mind you, people try this all the time, according to a Tax Office employee of my acquaintance. The other common 'mistake' is to ignore building depreciation when calculating CGT on sale.)

As you say, the Australian system grossly favours RE over other investments for people paying high marginal tax rates, as long as you see some level of price increase, and also favours investors over Owner-Occupiers. The politicians won't change things, because the last time someone tried (in 1986) there was more or less a landlord's strike in Sydney, and the private rental situation deteriorated so rapidly that the pollies backpedalled. In fact, backpedalled to the point where investers were MORE favoured than previously.

* Not Investment Advice - the rules may have changed since I was last a landlord in 1991 *

Peter P,

That's a perfect illustration of the bubble mentality. Most FB I meet are indeed driven by the fear of missing out.

Or as my mom says "it can't be bad if everybody is doing it - at least you won't look like an idiot that way."

The mortgage interest deduction cannot be responsible for the recent increase in home prices either in San Francisco or nationwide. It has been around for decades and prices have risen and fallen (in real terms) over that time. Why didn’t earlier homebuyers bid up prices? Is it different this time and today’s buyers are more intelligent, realize that the tax deduction has a benefit and have bid up prices?

You could use the same reasoning to show that neither prop 13 nor the $250,000 per person exemption was responsible for the rapid rise in home prices recently.

So what explain the rise in home prices in the Bay Area since 1996? The run-up in prices in the last 1990s was caused by the dot-com boom and justified. In the early part of this decade price stagnated or fell slightly because of the crash but the surprising fact is that prices started rising again in 2003 even while jobs were being lost in the Bay Area.

In my opinion the most recent price rise is due to a combination of speculation (purchasers not just buying for a place to live but in expectation of future gains in prices) and loose credit. The easy availability of interest only, negative amortization, low down payment and sub-prime loans allowed more home buyers to compete for housing even with the number of job holders and even population in the Bay Area falling slightly.

Evidence that the last two explanations are valid is the curious phenomenon of falling sales even with a good economy. In January 2007 sales were at the slowest since January 1996. This means that sales in today’s relatively good economy are even slower than during the recession in 2001. The drop in employment in San Jose during the last recession was the worst (as a percent of population) of any city since the great depression. Employment also fell substantially in San Francisco and the east Bay.

What would encourage people to buy during steep job losses but stop buying when there have been job gains? Speculation and easy credit.