How Would a 12% Mortgage Interest Credit Work

After we examined the final deficit commission report, some readers have asked us to compare how the proposed 12% mortgage interest tax credit would work relative to the present-law itemized deduction for mortgage interest. It is first important to keep in mind that the commission report is just a proposal, so the following contrast is hypothetical.

Under present law, in general, homeowners with a mortgage may deduct the amount of interest paid on a first or second home (interest allocable to up to $1 million in mortgage debt) plus interest paid on up to $100,000 of home equity loan debt. 

The amount of the home mortgage interest deduction is added to other permitted itemized deductions, such as expenses for real estate taxes, charitable contributions and state and local income/sales taxes. However, if the sum of these itemized deductions (as tabulated on Schedule A of the IRS 1040 return) is less than the permitted standard deduction (in 2010, $11,400 for married taxpayers filing a joint return; $5,700 for single returns), then the standard deduction is used in lieu of these itemized deductions because it offers a better deal.

To keep things simple, let’s assume that a homeowner has sufficient non-mortgage-related itemized deductions such that they would itemize their taxes even without a deduction for mortgage interest (i.e. would not claim the standard deduction).

For this example, let’s assume a married couple who are homeowners and face a 25% marginal tax rate. They paid $6,000 in mortgage interest in the year. In general, the deduction for mortgage interest will reduce their final tax liability by $6,000 times 25% or $1,500. The actual amount will of course depend on other itemized deductions and how close they are to the next tax rate bracket.

On the other hand, if the deduction for mortgage interest were converted into a 12% tax credit, instead of claiming the deduction, the taxpayer would calculate a tax credit. The value of the tax credit would equal 12% times $6,000 or $720. This tax credit is then used to reduce final tax liability.

This example assumes all other tax rules are held constant, so we can’t say what would happen ifother tax provisions are changed as well (and not enough detail is present in the commission report to calculate such examples). 

But this is how the 12% tax credit, as proposed, would operate.

0 replies

  1. regarding the deductible $1 million on interest, is this the total an individual can claim or is it $1 million on a 1st home and another $1 million they can deduct if they have a second home?


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