October 2003

Will Premiums Paid for Mortgage Insurance Soon Be Tax-Deductible?

By Mary-Jo Kranacher, CFE, CPA, York College

More than 12 million homeowners hope to get a tax break from their mortgage insurance premium payments, through recently proposed legislation. Whether private or government-backed, mortgage insurance was created to protect lenders from risk of loss in the event a borrower defaults on a mortgage loan. Private mortgage insurance (PMI) is currently required on all home purchases with a down payment of less than 20%. Government-backed mortgage insurance, such as through the Federal Housing Administration, is used for borrowers with less than 3% down and imperfect credit. Most homeowners pay the insurance as an added charge to their monthly principal, interest, tax, and insurance payments. This additional charge usually ranges from $50 to $150, depending upon the purchase price and the down payment shortfall.

With housing prices outpacing incomes, home loans needing private mortgage insurance increased 73% in 2001, representing a record $283 billion in new private mortgage insurance business, according to the Office of Federal Housing Enterprise Oversight. Allowing borrowers to deduct their annual mortgage insurance premiums might enable some potential homeowners, especially first-time homebuyers, to afford their own home. A reduction of after-tax mortgage costs might also qualify many previously ineligible renters to purchase a home.

Recent Legislation

Federal legislators recently proposed bipartisan bills in the U.S. House of Representatives (HR1336) and the U.S. Senate (S846) to amend the IRC to allow for mortgage insurance premium deductions. The considered legislation, which was also cited as the “Mortgage Insurance Fairness Act,” would have effectively treated the premiums paid for “qualified” mortgage insurance as “qualified residence interest.”

The bill had some restrictions, which primarily limited high-income taxpayers’ benefits. For example, the amount otherwise allowable as a deduction would be subject to a phase-out: a 10% reduction for each $1,000 that the taxpayer’s adjusted gross income for the taxable year exceeds $100,000 ($500 and $50,000, respectively, if married filing separate returns). Accordingly, this bill targeted middle-income borrowers, a majority of whom use private or government-backed insurance with their home purchases, as the main tax relief beneficiaries.

The IRS has argued that these payments are “service costs,” similar to appraisals, and therefore should not be tax-deductible. Yet, those familiar with the tax code understand that the purpose behind mortgage interest deductions on taxpayers’ personal residences—specifically, to encourage home ownership—applies to mortgage insurance payments as well. Furthermore, only lenders benefit from mortgage insurance. Claims are filed exclusively by them and are paid directly to them. On that basis, premiums perform essentially like interest payments and therefore should be tax-deductible.

The New York State Senate and Assembly proposed similar bills (S781 and A02511, respectively). Conformity between the federal and state laws concerning this issue would facilitate the “piggyback” approach for taxpayers that itemize their deductions. These versions also stated that in order to qualify for the deduction, the property related to the mortgage insurance must consist of no more than four dwelling units, one of which must be the taxpayer’s primary residence.

Although the fiscal implications have not been determined, the anticipated legislation, in all its renditions, has garnered much support. Those endorsing the bill included the Mortgage Bankers Association of America, the National Education Association, the Consumer Federation of America, and the National Taxpayers Union. In addition, influential House Ways and Means Committee members indicated strong interest in pushing the bill through by year’s end. Despite the strong bipartisan support, the much-anticipated mortgage insurance deduction never made it to the final, compromise $350 million tax bill recently passed by Congress and signed into law by President Bush. The issue remains alive and well, however, and will likely be revisited in the near future. There is a strong expectation that homeowners will eventually be able to list mortgage insurance premiums as part of their deductible expenses at tax time.

Edwin B. Morris, CPA
Rosenberg Neuwirth & Kuchner

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