Tax Expenditures in the Housing Sector
The housing sector is the recipient of some of the largest tax subsidies in the U.S. tax code. In fiscal year 2009, the estimated revenue lost by the federal government from housing-related tax expenditures topped $185 billion,1 with the vast majority of these subsidies supporting homeownership.
Tax expenditures are government revenue losses resulting from provisions in the tax code that allow a taxpayer or business to reduce their tax burden by taking certain deductions, exemptions, exclusions, preferential rates, deferrals or credits. Tax expenditures reduce the payment of taxes that would otherwise have been collected by the government, and thus have a similar effect on the federal budget as a grant program. They can also benefit recipients in much the same way as direct spending. For example, in order to boost demand for owner-occupied housing, the federal government provided tax credits of up to $8,000 to first-time homebuyers in 2009.2
Tax expenditures in the housing sector confer benefits to homeowners and renters, as well as the construction sector, developers, realtors and more. Subsidyscope illuminates the budgetary costs of these programs; however, any use of these data for policy evaluation must weigh those costs against the benefits they provide.
The 13 Tax Subsidies for Housing
Subsidyscope identified 13 tax expenditures from the U.S. Department of the Treasury's (Treasury) tax expenditure budget that benefit the housing sector.3 (Treasury categorized 12 tax expenditures in the housing sector, and Subsidyscope added “Exclusion of interest on veterans housing bonds,” based on its role in providing housing for veterans.) Subsidyscope further divided these tax subsidies into those that support homeownership and those that support rental housing. The five largest tax expenditures in the housing sector represent 91 percent ($168.7 billion) of all housing-related tax expenditures in fiscal year 2009. These five programs, all of which support homeownership, are described in more detail below. In addition, the largest tax expenditure for rental housing, “Exception from passive loss rules for $25,000 of rental loss,” is discussed below.
It is important to keep in mind that when a subsidy boosts the demand for housing, home prices may rise, especially in areas where the housing supply responds slowly to changes in demand.4 As a result, at least part of the tax benefit is capitalized into the price at the time the tax was enacted. Thus, the homeowner at the time of enactment was the primary beneficiary of the tax subsidy; to the extent that future homebuyers pay higher prices, the benefits they receive from the tax subsidy are offset by the higher price they pay for housing. Further, any reduction in the tax subsidy would potentially reduce current housing prices or cause them to grow more slowly over time depending on the specifics of the policy and how quickly it is phased in.
Table 1: Housing Related Tax Expenditures for Individuals and Corporations, FY 2009
| Tax Expenditure | FY 2009 ($ millions) |
|---|---|
| Deductibility of mortgage interest on owner-occupied homes | $79,400 |
| Deductibility of State and local property tax on owner-occupied homes | $29,010 |
| Exclusion of net imputed rental income | $27,040 |
| Capital gains exclusion on home sales | $23,500 |
| Credit for homebuyer | $9,730 |
| Exception from passive loss rules for $25,000 of rental loss | $6,020 |
| Accelerated depreciation on rental housing (normal tax method) | $3,860 |
| Credit for low-income housing investments | $3,800 |
| Exclusion of interest on owner-occupied mortgage subsidy bonds | $960 |
| Exclusion of interest on rental housing bonds | $810 |
| Deferral of income from installment sales | $720 |
| Discharge of mortgage indebtedness | $360 |
| Exclusion of interest on veterans housing bonds1 | $20 |
| Total | $185,2302 |
Source: Subsidyscope analysis of FY2009 data in Analytical Perspectives. OMB. Budget of the U.S. Government, Fiscal Year 2011. pp. 210-212. The estimates for 2009 tax expenditures vary based on the source used.
Notes:- Treasury categorized this tax expenditure in the “Veteran’s Benefits and Services” budget function. However, Subsidyscope deems this tax expenditure part of the housing sector based on the rationale that the exclusion is a housing subsidy for a particular group of citizens, and thus affects the housing market.
- Summing tax expenditures often provides a reasonably good estimate for the total cost of groups of tax expenditures, though it does not capture the potential interactions among tax expenditures if any single one is changed or repealed.
The Six Most Costly Housing Tax Subsidies (FY 2009)
Figure 1: Top Housing Tax Expenditures by Revenue Loss FY 2009 ($ billions)
Source: Subsidyscope analysis of FY2009 data in Analytical Perspectives. OMB. Budget of the U.S. Government, Fiscal Year 2011. pp. 210-212.
Owner-occupied home mortgage interest deduction: $79.4 billion
The largest tax expenditure in the housing sector for fiscal year 2009 was the mortgage interest deduction (MID) on owner-occupied homes, with an estimated revenue loss of $79.4 billion.5 This tax subsidy allows homeowners to claim an itemized deduction on their taxes equal to the amount they pay in interest on their mortgage and a home equity loan (up to $1.1 million in mortgage debt). Homeowners may also deduct interest on the first $1.1 million in mortgage debt and home equity indebtedness for a second residence.6
From an economic perspective, a home produces a stream of benefits to its owner in the value of the implicit rental income (what a homeowner could earn if they rented the home to someone else; see more below on imputed rent). This income is not taxed for various reasons, one being the administrative difficulties that would be involved in trying to calculate such a tax. If the implicit rental income were taxed, a homeowner would deduct any expenses they incurred to earn that income, such as interest on a mortgage or taxes on the property, but then neither the MID nor the property tax deduction would constitute a subsidy.7 However, neither the interest on the mortgage nor the imputed rental income is taxed, therefore the MID constitutes a subsidy to homeowners.
Given that homeownership is considered part of the American Dream, the MID garners great support and popularity across the country.8 In fact, it has been said to rival Social Security as the “third rail” of U.S. politics.9 However, in recent years many have raised concerns over the effect of the deduction on the budget, and reform options have been discussed by the Congressional Budget Office,10 the Urban Institute11 and the President’s National Commission on Fiscal Responsibility and Reform.12 A forthcoming report by The Pew Fiscal Analysis Initiative and Subsidyscope will explore the implications of reform for households.
Deductibility of State and local property tax on owner-occupied homes: $29 billion
The second largest housing-related tax expenditure in fiscal year 2009 was the deduction for property taxes paid on owner-occupied residences, with an estimated revenue loss of $29 billion.13 This provision allows certain homeowners who pay property taxes to state or local governments to claim an itemized deduction on their federal income taxes for those property taxes paid. The Congressional Research Service (CRS) notes that the rationale behind this deduction is that taxes paid to state or local governments reduce a taxpayer’s ability to pay federal income tax, and therefore should be deducted before calculating the federal income tax owed.14
CRS states that this provision subsidizes homeowners as well as state and local governments.15 Further, like the mortgage interest deduction and other tax expenditures targeted to homeowners, this tax subsidy reduces the cost of owning a home relative to renting.16
Exclusion of net imputed rental income: $27 billion
In addition to benefiting from the investment value of a home, the homeowner benefits financially from not having to pay rent (to themselves) because the home could have produced a stream of rental income if it were to be rented out. The value of this foregone rent is called ‘imputed rental income.’ A pure income tax would require a person to pay taxes on their imputed rental income (including any capital gains income) less the costs of owning and maintaining their home, such as mortgage interest and depreciation. There are various reasons why such income is not taxed in practice, including difficulties with implementation of such a tax. However, not taxing the net imputed rental income a person receives from living rent-free in their home is considered a tax expenditure by the Treasury.17
Capital gains exclusion on home sales: $23.5 billion
As previously noted, a pure income tax would apply to any capital gains that a homeowner earns on the home. However, a homeowner may exclude up to $250,000 ($500,000 for married taxpayers who filed jointly) of capital gains on the sale of a principal residence (no more than once every two years).18 In fiscal year 2009, this exclusion represented an estimated $23.5 billion in lost tax revenue for the Treasury.19 A ‘capital gain’ on a residence is the profit made on a house, or the increase in value from the time that a home was purchased to the time it was sold, less the value of improvements.
CRS notes that this exclusion “gives homeownership a competitive advantage over other types of investments, since the capital gains from investments in other assets are generally taxed when the assets are sold.”20 Combined with the other tax preferences for housing listed here, this makes homeownership a particularly attractive investment.
Credit for homebuyers: $10 billion
The Housing and Economic Recovery Act of 2008 established a tax credit for first-time homebuyers worth up to $7,500.21 The American Recovery and Reinvestment Act of 2009 expanded the first-time homebuyer credit by increasing the credit amount to $8,000 for purchases made before December 1, 2009.22 The Worker, Homeownership and Business Assistance Act of 2009 extended the purchase deadline to May 1, 2010 (with a closing deadline of July 1, 2010),23 and legislation enacted in July 2010 extended the closing deadline for the purchase of a first home to September 30, 2010.24
Exception from passive loss rules for $25,000 of rental loss: $6 billion
The largest tax expenditure for rental housing is the exception from passive loss rules for rental loss. ‘Passive activities’ are “those in which the taxpayer does not materially participate . . . [T]here are numerous additional considerations brought to bear on the determination of which activities are passive for a given taxpayer.”25 Under the Internal Revenue Code, losses that result from passive activities are generally not allowed to be deducted from taxable income unless that income is also passive.26 However, exceptions apply in certain cases, such as for rental losses. Although investments in rental properties are considered passive activities, the owner of such a property may deduct up to $25,000 of loss from non-passive taxable income as long as the taxpayer actively participates in the property and meets the income requirements of less than $100,000 a year.27
Homeownership Receives 92 Percent of Housing Tax Subsidies
The list of housing tax subsidies can be categorized to compare those that benefit homeownership and those that benefit rental housing. The chart below illustrates that nearly all (92 percent or $171 billion) of federal income tax subsidies for housing benefit homeownership. In addition, all four tax expenditures in the rental category go to the owners of rental property, but the assumption is that some of the tax benefits are passed on to renters. Tax subsidies to rental property owners benefit renters to the extent that the owners voluntarily, or as a condition of the subsidy, are compelled to lower rents or increase the stock of rental properties available.28
Table 2: Housing Tax Expenditures that Support Homeownership and Rental Activity, FY 2009
| Tax Expenditure | FY 2009 ($ millions) |
|---|---|
| Supports Homeownership Activity | |
| Deductibility of mortgage interest on owner-occupied homes | $79,400 |
| Deductibility of State and local property tax on owner-occupied homes | $29,010 |
| Exclusion of net imputed rental income | $27,040 |
| Capital gains exclusion on home sales | $23,500 |
| Credit for homebuyer | $9,730 |
| Exclusion of interest on owner-occupied mortgage subsidy bonds | $960 |
| Deferral of income from installment sales1 | $720 |
| Discharge of mortgage indebtedness | $360 |
| Veterans Housing Bonds | $20 |
| Total | $170,740 |
| Supports Rental Activity | |
| Exception from passive loss rules for $25,000 of rental loss | $6,020 |
| Accelerated depreciation on rental housing (normal tax method) | $3,860 |
| Credit for low-income housing investments | $3,800 |
| Exclusion of interest on rental housing bonds | $810 |
| Total | $14,490 |
| Grand Total | $185,2302 |
Source: Subsidyscope analysis of FY2009 data in Analytical Perspectives. OMB. Budget of the U.S. Government, Fiscal Year 2011. pp. 210-212.
Notes:- The deferral of income on installment sales is not explicitly related to either homeownership or rental activity. The CRS notes that "the primary benefit probably flows to sellers of farms, small businesses, and small real estate investments." CRS. "Tax Expenditures: Compendium of Background Material on Individual Provisions." Prepared for the United States Senate Committee on the Budget. December 2008. p. 403.
- Summing tax expenditures often provides a reasonably good estimate for the total cost of groups of tax expenditures, though it does not capture the potential interactions among tax expenditures if any single one is changed or repealed.
- Subsidyscope analysis of data in "Analytical Perspectives." See: Office of Management and Budget (OMB). "Analytical Perspectives, Budget of the U.S. Government, Fiscal Year 2011." pp. 210, 212.
- The credit was established in the Housing and Economic Recovery Act of 2008 and later expanded in various bills. See: Internal Revenue Service (IRS). "First-Time Home Buyer Credit." Last Updated: September 9, 2010.
- Treasury reports a tax incentive for the preservation of historic structures that Subsidyscope does not include in this analysis. Under this provision, owners of historic buildings are encouraged to preserve or restore them with a tax credit of up to 20 percent of the expenditures used to convert the building. This tax credit, estimated to cost $430 million in fiscal year 2009, can be used to create both rental housing and commercial property; thus it cannot be wholly attributed to the housing sector. Because Treasury does not list it in the housing budget function, Subsidyscope has chosen to exclude this tax credit from its totals for the housing sector. See: Congressional Research Service (CRS). "Tax Expenditures: Compendium of Background Material on Individual Provisions." Prepared for the United States Senate Committee on the Budget. December 2008. p. 377
- Carroll, Robert, John O’Hare and Philip Swagel. “Costs and Benefits of Housing Tax Subsidies.” Pew Fiscal Analysis Initiative and Subsidyscope Paper. The Pew Charitable Trusts: Washington DC. Forthcoming. p. 7.
- OMB. "Analytical Perspectives, Budget of the U.S. Government, Fiscal Year 2011." p. 210.
- CRS. "Tax Expenditures: Compendium of Background Material on Individual Provisions." Prepared for the United States Senate Committee on the Budget. December 2008. p. 329.
- This follows the broad principles of a comprehensive income tax in which one would deduct the costs or expenses of a business before the business income is taxed. However, neither the interest on the mortgage nor the net imputed rental income is taxed, constituting a subsidy to homeowners. See Carroll, Robert, John O’Hare and Philip Swagel. “Costs and Benefits of Housing Tax Subsidies.” Pew Fiscal Analysis Initiative and Subsidyscope. The Pew Charitable Trusts: Washington DC. Forthcoming. p. 19
- For example, the National Association of Home Builders' September, 2010 poll and CNN's November, 2010 poll showed significant support for the MID.
- Toder, Eric, Turner, Marjery Austin, Lim Katherine and Getzinger, Lisa. “Reforming the Mortgage Interest Deduction.” The Urban Institute. Washington, DC. April 2010. p. 2.
- Congressional Budget Office (CBO). “Budget Options, Volume 2.” August 2009. p. 187.
- Toder, Eric; Turner, Marjery Austin; Lim Katherine; and Getzinger, Lisa. “Reforming the Mortgage Interest Deduction.” The Urban Institute. Washington, DC. April 2010. p. 6.
- The National Commission on Fiscal Reform and Responsibility. “The Moment of Truth.” December 2010. p. 30.
- OMB. "Analytical Perspectives, Budget of the U.S. Government, Fiscal Year 2011." p. 210.
- CRS. "Tax Expenditures: Compendium of Background Material on Individual Provisions." Prepared for the United States Senate Committee on the Budget. December 2008. p. 337.
- Ibid., p. 335.
- Ibid.
- Treasury began calculating this tax expenditure in 2004, according to this JCT report. The JCT does not consider imputed rent in its tax expenditure estimates.
- OMB. "Analytical Perspectives, Budget of the U.S. Government, Fiscal Year 2011." p. 230.
- Ibid., p. 210.
- CRS. "Tax Expenditures: Compendium of Background Material on Individual Provisions." Prepared for the United States Senate Committee on the Budget. p. 351.
- This first $7,500 credit had to be paid back to the Treasury. See: IRS. "First-Time Home Buyer Credit." Last Updated: September 9, 2010.
- IRS. "The American Recovery and Reinvestment Act of 2009: Information Center." Last Updated: July 6, 2010.
- IRS. "First-Time Home Buyer Credit." Last Updated: September 9, 2010.
- Ibid.
- OMB. "Analytical Perspectives, Budget of the U.S. Government, Fiscal Year 2011." p. 230.
- IRS. "Passive Activity Loss ATG- Exhibit 2.6 Equipment Rentals IRC § 469 (c)(2) and Reg. §1.496-1T(e)(3)." Last Updated: March 10, 2008.
- IRS. "Passive Activity Loss ATG- Chapter 2, Rental Losses." Last Updated: March 10, 2008.
- Based on Subsidyscope analysis of CRS. “Overview of Federal Housing Assistance Programs and Policy.” July 22, 2008. p. 14.