Abstract

This paper presents a novel analysis of the differential incidence and effect of Federal income tax policy on owner-occupied and rental housing in the U.S. The objective is to examine whether, and how, rental housing is penalized relative to owner-occupied housing, and if so to estimate the magnitude of any such penalty that is caused by Federal income tax policy. The findings of the analysis suggest that a penalty does exist on rental housing relative to owner-occupied housing, and that the magnitude is substantial. On a present value capitalized basis the relative penalty is likely on the order of one-quarter the value of the housing. The model presented in this paper is novel in that it applies the basic tenets of modern corporate finance theory to identify the sources and magnitude of the differential tax impact. The causes of the differential impact that are thusly identified suggest a policy remedy that differs from the one traditionally proposed, which is simply to eliminate the home mortgage interest tax deduction. Instead, the analysis herein suggests that the home mortgage tax deduction is not the source of the differential tax impact (for one thing, interest on mortgages financing rental apartments is also deductible from the landlord’s taxable income, and for another, lenders providing the mortgage capital are generally taxable investors on the margin). Rather, the model presented here implies that the more direct and appropriate policy remedy would be to allow apartment investment income to be deductible from taxable income. This could also be a more politically feasible policy than to remove the mortgage deduction.

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