Tuesday, July 17, 2012

Those who own their houses with equity also get a tax break.

Matthew Yglesias, who wrote a terrific piece on the benefits of off-shoring yesterday, also wrote a piece on why Mark Zuckerberg has a mortgage:
Bloomberg writes that "wealthy individuals often choose to finance a home purchase rather than pay cash because of the overall low cost of mortgage debt and the additional access to liquidity," which is true but I think only scratches the surface. Another important issue is that interest payments are tax deductible, which is a very big deal if you have a very high income and live in a high-tax state like California.
But owning with equity gives the same tax break as owning with debt--the return one earns on her house (the rent she pays herself) go untaxed. Consider the following experiment: suppose you and your neighbor own your houses free-and-clear. Now you swap houses and charge each other market rent--you are now responsible for paying income taxes on that rent. The value of the tax break by staying in your own home is your marginal tax rate multiplied your return on equity. The return on equity is generally called net imputed rent.

The mortgage interest deduction places debt and equity on a level playing field when it comes to homeownership. Thus the many countries without a mortgage interest deduction, such as the UK, Canada, and Australia, still subsidize owner housing--they simply encourage people to own with equity instead of debt. This may be a very good idea.

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