Move-up Housing Cashes in on Tax Law

Move-up madness, which stimulated the U.S. housing market in 1986, is expected to be increasingly significant to both the new- and existing-housing markets this year.

The reason is fairly simple. It’s one of those under-publicized aspects of the Tax Reform Act of 1986, which does even more than merely preserve the traditional tax write-off for interest on home mortgages. In 1987, those mortgage interest deductions will add up to an estimated $27 billion.

Baltimore real estate executive Mary Bell Grempler pointed out recently that some ramifications of the tax reform law will make “moving up” (purchasing a more expensive house) more attractive--almost imperative--for many homeowners.

Grempler said, “People will be moving up more than in the past because they will need the increased equity in the house to borrow against. When you borrow against the house the interest paid will be tax deductible, but that’s not the case with most other loans under the new tax laws.”

Experts who have analyzed the new tax law tell us that in 1987 there will be--for the first time--limitations on the traditional mortgage interest deductions available to homeowners who refinance their dwellings or borrow against their equity in the house in which they live.

Those limits were put into the new tax bill to thwart homeowners who might be tempted to try to avoid the gradual elimination of deductions for credit charge interest and loans for cars or boats or whatever.

If you borrowed or refinanced before Aug. 16, 1986, you got in under the wire. But now, refinancing loans will not be fully deductible if the loan amount exceeds the current value of the house on which the new loan is made. In simple terms, you now can deduct the mortgage interest only on the amount of the original purchase price of a home plus the cost of any improvements.

Now we’re getting to the part that is expected to stimulate homeowners to sell and move up--particularly if they have owned their house for a long time and the real value of the house has increased considerably.

Let’s take the case of Bill and Linda, who bought the then-new house in which they live for $70,000. That was 12 years ago. They have put only about $10,000 into the house for improvements beyond the needed replacements (like a new roof or painting, which are not regarded as improvements but as maintenance). So Bill and Linda now have $80,000 in their home and their $60,000 mortgage is reduced to about $50,000. But today, houses in their neighborhood are reselling for $225,000 to $250,000.

That’s great for Bill and Linda, unless they want to refinance their house or get a second mortgage to get some cash to buy a boat. If they now want to increase their mortgage, the only portion that will be interest deductible is the $80,000. That’s the amount they paid plus the improvements. So they could refinance and get $30,000 more and still stay within the deductible interest limit on mortgages.

But their home is now worth $240,000. So, if they really wanted to have $130,000 in cash, they could easily refinance and get that much without pushing the limit of their mortgage financing potential. But any amount over $30,000 would not qualify for interest deduction. So what can they do?

Grempler and others point out that homeowners caught in that dilemma often sell their present home, take their equity and profit and use some for a down payment on a new, more expensive house. Their mortgage is bigger, but all of the interest will be deductible.

In the case of someone like Bill and Linda, they might net (after paying off the current mortgage and paying the selling commission) nearly $175,000 from the sale of their current house. Then, assuming that they decide to buy a $300,000 house, they might use $100,000 as a down payment and get a $200,000 mortgage. And all of the interest on that $200,000 would be tax deductible and the couple would still have about $75,000 left over to buy a boat for cash. Another couple might use the money to put a child through college.

No wonder that a survey of 5,000 recent home buyers (by the National Assn. of Realtors) showed that more than half were most attracted by tax and investment advantages of home ownership.