A proposal to cap the mortgage interest deduction for new purchases of expensive homes was among the most talked-about aspects of the tax overhaul rolled out by House Republicans last week.
But the plan takes aim at the mortgage interest deduction in another way, too, by eliminating deductions for mortgages on second homes. This could have a significant impact on certain areas of the country where vacation and second homes make up a disproportionate chunk of the local housing market.
According to the Census Bureau's American Community Survey, homes classified as “for seasonal, occasional or recreational use” tend to be clustered along the coasts and in mountainous areas.
In Hamilton County, N.Y., in the heart of the Adirondack Mountains, more than 80 percent of dwellings are seasonal or vacation homes — the highest share in the country. Second homes are also highly concentrated in Vermont, New Hampshire and Maine.
Other hotbeds of second-home ownership include the Appalachian Mountains, the Rockies and the northern reaches of Michigan, Wisconsin and Maine.
The changes to mortgage interest would apply only to upcoming loans — current mortgage holders with first and second homes would continue to be able to take the same interest payment deductions as under existing law. But if Republicans' plan becomes law, home prices in these regions are likely to be the most affected by the loss of the second-home deduction.
Second homes make up a small but significant chunk of the U.S. housing market. According to the National Association of Realtors, 12 percent of residential properties purchased in 2016 were vacation homes. Buyers used mortgages to finance 72 percent of vacation-home purchases that year.
The thinking behind the mortgage interest deduction is that it allegedly incentivizes homeownership. It makes sense for the federal government to encourage home-buying, the thinking goes, because real estate has traditionally been a driver of middle-class wealth in this country. For many Americans, their home is quite literally their retirement fund.
But that line of thinking has come under fire in recent years. Economists have generally come to agree that the mortgage interest deduction doesn't incentivize homeownership; it just encourages people to buy bigger, more-expensive homes — driving up prices in the process. Homeownership rates in the United States are comparable to those in other wealthy countries such as Canada, Australia and Britain — none of which make mortgage interest tax-deductible.
Beyond that, economists have noted that the benefits of the American mortgage interest deduction flow primarily to the already wealthy. In 2013, 70 percent of the total value of the deduction went to the richest 20 percent of households. The 1 percent alone gobbled up 15 percent of the deduction.
If the case for deducting interest on primary residences has grown shaky, then the case for doing it on vacation homes is even more so. The policy further inflates housing prices in resort areas, where many of the year-round residents can't afford them to begin with. Meanwhile, the ultra-wealthy use a loophole in the second-home deduction to write off the interest on their yachts.
The census data indicates that there are over 5 million seasonal, vacation or recreational homes in the United States that sit vacant all or part of the year. That's an awful lot of empty space to be subsidizing via the tax code.