Did You Know: The mortgage interest deduction (MID) was capped at $1 million in 1987 and not pegged to inflation. If it had been indexed, the MID cap would be over $2 million today.

  • In 1987, following tax reform in 1986, the mortgage interest deduction was capped. Only interest on mortgages up to $1 million was deductible. For context, at the time the median priced single-family home was $85,600.
  • Many tax parameters are indexed for inflation and the indexing began at a variety of points in time. For example, the earned income credit (1984), the standard deduction (1987), the personal exemption (1988), the tax rate tables (1989), the old phaseout of personal exemptions and limitation on itemized deductions (1990) [1], the 10 percent bracket (2002) [2], and the new phaseout of personal exemptions and limitations on itemized deductions, AMT, and 39.6 percent bracket (2013) [3] are all indexed for inflation. The inflation adjustment ensures that inflationary increases alone do not push tax payers into higher marginal tax rates or erode benefits like the standard deduction.
  • While the mortgage interest deduction cap remains unchanged, the price of single-family homes has more than doubled in 25 years even after the house price declines of the Great Recession. In 2012, the median priced single-family home sold was $177,200 (slightly higher than the median priced existing home which sold for $176,800). The most recent monthly price was above $200,000 and given the pattern of price increases, the median priced home sold in 2013 will probably be near that level.
  • Financiers often use a “rule of 72 [4]” to figure out how long it takes something that is compounding to double or how long it takes for purchasing power to be cut in half by inflation. To use the rule, take the rate of return or the inflation rate and divide 72 by that number. In the last 30 years, inflation has averaged about 3 percent. Using the rule of 72, that would suggest that in the last 24 years, purchasing power has been cut in half.
  • So while home prices have doubled and purchasing power has been roughly halved, the Mortgage Interest Deduction cap has not budged. If it had been tied to the inflation measure used to adjust other tax items, the MID cap would be over $2 million today.

[1] http://www.irs.gov/pub/irs-tege/rp92_102.pdfpdf
[2] http://taxfoundation.org/article/inflation-adjustment-tax-brackets-almost-zero-next-year
[3] http://taxfoundation.org/blog/details-fiscal-cliff-tax-deal
[4] Sometimes called the “rule of 70” or “rule of 69.” See here: http://en.wikipedia.org/wiki/Rule_of_72