Replacing the mortgage interest deduction with a first-time home buyers tax credit or a nonrefundable credit at a set percentage of interest would provide a homeownership tax incentive to more families, including those with lower incomes.
The Tax Cuts and Jobs Act of 2017 (TCJA) dramatically changed tax subsidies for homeownership by raising the standard deduction, placing a cap on the deduction for state and local taxes, and lowering the maximum mortgage for which interest can be deducted.
Although tax incentives for homeownership are intended to increase the number of homeowners, they have some drawbacks. For example, they distort the allocation of resources into more costly housing and away from potentially more productive assets. This could raise home prices, making homeownership less affordable for low-income taxpayers and first-time homebuyers.
The subsidies also reduce federal government revenues ($242.9 billion in 2022, according to the US Treasury Department), and research suggests that they do not increase homeownership rates. In addition, the tax incentives are mostly used by high-income taxpayers who have enough resources to make mortgage payments without a subsidy.
There are several possible ways to reform these incentives. First, the federal government could provide a tax credit for first-time homebuyers. As an example, during the Great Recession, from 2008 through 2010, a temporary tax credit, with a maximum value of $7,500 in 2008 and $8,000 in 2009 and 2010, was available for first-time homebuyers. Reimplementing such as credit as a permanent policy could help make homeownership more accessible for lower-income households.
Alternatively, the mortgage interest deduction (MID) could be replaced with a 15 percent mortgage interest tax credit. The MID is available only to those who itemize their deductions, who tend to be high-income taxpayers. Because the MID reduces taxpayer’s taxable income, it provides larger benefits per dollar of interest paid to higher-income taxpayers who face higher marginal tax rates.
A tax credit, on the other hand, could be available to those who use the standard deduction. And by reducing taxes by a fixed percentage of interest, rather than taxable income, a credit would not disproportionately benefit high-income taxpayers.
Similarly, the federal deduction for property taxes could be replaced with a credit. As with a credit for mortgage interest, this would offer more benefits to low-income households.
Finally, the cap on the MID, currently $750,000 but set to increase to $1 million at the end of 2025, could be lowered to $500,000. This would limit the subsidy going to high-priced houses and reduce the regressivity of the deduction.
Updated January 2024
US Department of the Treasury. 2023. “Tax Expenditures.” Washington, DC: US Department of the Treasury.
Eng, Amanda, Harris, Benjamin H., and C. Eugene Steuerle. 2014. “New Perspectives on Homeownership Tax Incentives.” Washington, DC: Urban Institute.
Lu, Chenxi, Eric Toder, Surachai Khitatrakun, and Robert McClelland. 2020. “Effects of Tax Incentives on Homeownership.” Washington, DC: Urban-Brookings Tax Policy Center.
C. Eugene Steuerle. 2020. “Biden’s First-Time Homebuyer Tax Credit Is a Big Improvement over the Mortgage Interest Deduction.” TaxVox (blog). Washington, DC: Urban-Brookings Tax Policy Center.
Lu, Chenxi, Joseph Rosenberg, and Eric Toder. 2015. “Options to Reform the Deduction for Home Mortgage Interest.” Washington, DC: Urban-Brookings Tax Policy Center.