Rottenchester

Did it occur to any of you geniuses that with increased income, we qualify for larger mortgages and need the increased mortgage interest deduction in order to limit tax liability?

Let's do a little back-of-the-envelope math. He's in DC. I'm in Rochester. We both have some cash to buy a similar house. Assume we can both afford to put up 1/3 of the equity of comparable house. I buy a $150K house, and get a $50K mortgage. He buys a $450K house (since, according to the Washington Post, property values in DC are 3X those in Rochester). He carries a $300K mortgage.

After one year, at 6%, for a 15 year mortgage, he's paid $17K in interest and $12K toward principal. I've paid $3K in interest and $2K in principal.

Even though he makes more than me, we're both rich by government standards, so we're taxed at the highest rate. To make the math easy, let's say we're both taxed at 33%, roughly 1/3 of our incomes.

Because of the mortgage deduction, the $17K in interest he paid reduces his adjusted gross income by $17K, which means that he pays roughly $5,600 (1/3 of $17K) less in taxes. My income is reduced by $3K, so I pay about $1K less in taxes.

Bottom line: after taxes, he still paid $12,400 in interest, never to be seen again. I paid $2,000 in interest. He paid $10K more in interest alone than I did for an equivalent house for one year.

The mortgage deduction did not mitigate this at all - it is really irrelevant and a poor reason to buy a house in the first place. Tax deductions, in general, are rarely a reason to make a financial move. But since people hate taxes so much, financial planners and bankers make a big deal about tax deductions when they're selling financial products.

The other fact our friend from DC ignores is that that taxes for people making more than $150K/year fall under AMT - Alternative Minimum Tax - which limits deductions. When you make the kind of bread you need to make to live in DC, you're also going to be paying a hell of a lot of taxes.

So, who's the "genius" in this picture, DC? There's no magic bullet. If it costs 3X more to buy an equivalent house in DC than it does in Rochester, then you either have to make 3X more, or settle for less.