News Column

Are Mortgage Tax Deductions in Play?

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The U.S. Congress is on the verge of a complicated process that will juggle federal spending against its tax codes and laws, with a lot of items on the table to avoid falling off what has been dubbed a "fiscal cliff."

But many people in Inland Southern California believe that eliminating the mortgage interest deductions for homeowners would be a catastrophic move for an area that was practically the launching pad for the real estate crash that triggered 2008's Great Recession. Tax reform has been a frequent campaign issue this year, with tax cuts enacted under former President George W. Bush scheduled to expire at the end of this year.

If homeowners would no longer be allowed to deduct the interest that they paid on a mortgage and claim a refund for many the only significant deduction they can put on their 1040 forms and the only sizable check outside of a paycheck they receive from any source -- it might convince thousands that their best move is to walk away from their homes, experts say. It could also curtail many Inland consumers' discretionary spending and hurt the retail sector of the economy,

No one knows how large a role tax deductions on mortgage interest will play in the Washington debate as Congress tries to deal with spending and taxes. Experts predict it would be unlikely that any new policy would wipe out the deduction entirely in one year. The more likely scenario would be a phased-in program that starts with very expensive homes, few of which are in the Inland Empire.

But many middle-income taxpayers see mortgage interest deductions as the only break they get. According to a recent Pew Research Center study, the best definition of middle income is about $68,000 for a family of four. Most at that level might contribute something to their church or write a modest check to the Red Cross but are not likely to accumulate enough charitable contributions to make a big difference at tax time.

"I don't know why they took away the other deductions, like the car notes and the credit cards," Ronald Newton, a 72-year-old retired shipyard foreman who lives in Menifee, referring to tax code revisions made in the mid-1980s. "About the only thing I have left is my mortgage."

What makes it especially worrisome in San Bernardino and Riverside counties is that more than half of the homeowners currently still paying mortgages owe more on the home than it would currently appraise for.

"This would have a devastating impact when you figure that 51 percent of all our homeowners are underwater," Redlands-based economist John Husing said.

According to the congressional Joint Committee on Taxation, an estimated 40 million homeowners take this deduction every year, and the average savings for them is about $600. The mortgage deduction shrinks the federal government's coffers by about $82 billion a year.

No politicians have proposed an outright elimination of the deduction. But Richard Green, director of the Lusk Center for Real Estate at the University of Southern California, testified last year before the U.S. Senate Banking Committee that the deduction, which has been around for almost 100 years, is outdated and does not encourage homeownership.

What it does is encourage debt and spur consumers to purchase bigger houses than they would otherwise. Green told senators a tax credit for buyers would go further in getting first-time buyers into homes.

But the deduction is probably much higher for many Inland homeowners when the huge housing bubble and the resulting crash are factored in. Prices peaked late in 2006 at $430,000 for the median-priced home in Riverside County and $380,000 in San Bernardino County. The median price in September was $212,500 in Riverside County, and $170,000 in San Bernardino County, according to DataQuick, a real estate information service.

Husing said that many people are still making regular payments on a house purchased for well more than it is worth now and have little cash left over after writing that check.

"If you take away the mortgage interest deduction you'd take away part of their income, and we're not talking about very wealthy people," Husing said.

Daren Blomquist, vice president for RealtyTrac, an online real estate and foreclosure tracking firm, estimates that 71,000 people in Riverside County alone are underwater by more than $150,000, and it would not take much more to trigger many of them to walk away and let the lender foreclose.

That's a process that could take a year, and while it's happening, large parts of neighborhoods could fall into decay due to abandoned homes.

"It would be very detrimental in the Inland Empire," Blomquist said. "Many more would walk away."

Already, one in every 73 Inland homes, more than three times the national average, was in some phase of the foreclosure-related process, according to a third-quarter report from RealtyTrac.

Curtailing the mortgage deduction would be a move that would curtail the area's recovery, other real estate professionals say. Rich Simonin, co-owner of Riverside's Westcoe Realty, said it would have a negative effect on the market that sellers, buyers, escrow agents and others would feel.

"We're already numb from being hit over the head," Simonin said. "This would not be a minor shift. It would be a huge fundamental change in the dynamics of real estate."

Hector Sanchez, a Realtor with ReMax Advantage in Redlands, said it could make some buyers hesitant to get into the market. "I think we're so fragile right now," he said of the Inland area. "This is where the bomb went off."

Taking a deduction for mortgage interest is considered an important part of many taxpayers' financial plan, said Jamil Dada, vice president for investments at Riverside-based Provident Financial Holdings. Frequently he advises clients not to pay down extra mortgage debt and use excess cash to take care of other payments.

The reason, Dada said, is that credit cards and other debt are not tax-deductible.

"It's more beneficial to have cash flow," Dada said.

The deduction also means a check that is for some people one of the few breaks they get all year. Tamara Rose, 39, a teacher who lives in Riverside, said the tax refund she gets every year pays down credit card balances and takes care of surprise expenses.

"We need every tax break," Rose said. "It's the only way we can save anything."

It's also a boon for many retailers and sometimes the only boon. Mike Rustai, general manager of American Wholesale Furniture and Mattress in Temecula, said business always picks up late in the winter and early in spring, when refund checks go out. It serves as an economic boost, and city treasuries see an uptick in sales tax revenue.

"People get a decent check and they spend," Rustai said.

Dada, who frequently visits Washington, D.C., as a ranking official of the National Association of Workforce Boards, said it would be unlikely the deduction would be eliminated outright because hitting middle-class taxpayers that hard would be politically dangerous.

In an interview, Green said that Inland residents should probably not worry, at least for now. His guess is that Congress would look at mortgages worth $1 million first and possibly drop that level down over a period of years.

That means it would affect homeowners in coastal Los Angeles and San Francisco but very few in the Inland Empire, and it's possible the Inland area might not feel this, if it happens, for a long time.

"It's one thing to look at an ideal policy, and another to get there," Green said.