The hottest consumer-financing concepts in America -- home equity loans and credit lines -- have entered the sights of a key congressional committee.
The staff of the influential Joint Committee on Taxation, which advises both the House and Senate on tax policy issues, has proposed eliminating interest deductions for all second mortgages and credit lines. The proposal is included in a wide-ranging "options" paper that identifies revenue-raising measures to stem the federal budget deficit, simplify the tax code and "improve tax compliance."
The staff paper also proposes eliminating the tax-free status of income received by homeowners when they rent out their properties for less than 15 days a year.
The curtailment of home equity deductions would raise an estimated $22.6 billion in federal taxes between 2005 and 2009, according to the committee staff. The home rental proposal would raise far less, an estimated $100 million.
Both proposals are potentially highly controversial and may never make it into legislation. The home equity plan in particular takes aim at popular products. Home equity lines and second mortgages accounted for nearly $400 billion in new loan business for banks during the fourth quarter of 2004 -- up from $285 billion during the corresponding period the year before, according to the Federal Deposit Insurance Corp. At thrift institutions, home equity lending increased 62.5 percent in 2004, to $79.3 billion, according to the federal Office of Thrift Supervision.
Some banks have seen their home equity business more than double in the past 12 months. According to the lending industry trade newsletter, Home Equity Wire, Bank of America increased its home equity originations by 167 percent in the past year, racking up $16.2 billion in new loans during the final quarter of 2004.
A key attraction of home equity lines and mortgages is the federal tax-deductibility of interest payments, which reduces the effective cost of the loans to borrowers. Better yet, equity line dollars can be spent on anything, while all other forms of consumer debt receive no federal tax preferences.
The tax committee staff cites that disparity between federal tax treatment of ordinary consumer debt and home equity debt as one reason to change the law.
"Effectively, present law gives unequal treatment to otherwise similar interest costs based on whether the debtor owns a home. This result is inequitable" to all other taxpayers who rent or have little or no equity in a home, according to the committee staff.
The inequity extends to entire regions of the country where home appreciation rates are lower than others and growth of home equity is slower.
"This tax benefit is more valuable to homeowners in areas with price-appreciated homes than to homeowners with flat or declining home prices," according to the report.
Without identifying specific regions, the committee staff appeared to imply that the high-price, high-gain markets of the East and West coasts are unfairly favored by the tax code's home equity deductibility provisions, at the expense of lower-inflation, more moderate-growth markets elsewhere.
The tax code allows homeowners to take interest deductions on up to $100,000 of home equity lines or second mortgages, in addition to interest write-offs on up to $1 million in first-lien mortgage debt. The committee staff derided the home equity tax preferences as superfluous icing on the already rich homeownership cake.
"It is unlikely," said the staff paper, "that the deduction for interest on home equity debt significantly adds to present law incentives to encourage homeownership because most decisions to purchase a home are unlikely to be affected by the ability to deduct home equity" interest payments.
"Individuals who benefit from [the current rules] have already achieved homeownership and are unlikely to stop being homeowners because the home equity debt rules are repealed."
The staff paper criticized the tax-free treatment of home rental income under 15 days a year for essentially closing the government's eyes to what is often substantial income. The rental loophole is used by homeowners in areas that receive periodic, large influxes of short-term visitors -- the Masters golf tournament, for example, or the Super Bowl. Owners of homes or condos can earn $10,000, $20,000 or more tax-free by renting out their properties to corporations or people attending an event.
Under the committee staff's proposal, owners' tax-free earnings would be capped at $2,000. Everything after that would be subject to ordinary income taxation.
The political outlook for both proposals? Stormy weather, at best. But their existence as recommendations ready to be crafted into legislation by a professional tax staff should never be discounted at a time when the federal budget is spurting record amounts of red ink.