Mortgage Interest Deduction is Illusory

a bit simplistic, steve? two things:

1. I think the people you are arguing against inherently agree with that basic point. That is, they believe that high real estate values are in part justified for the very reason that they DO take the mortgage deduction into account. I don't think anyone argues that the mortgage deduction is some kind of unknown benefit that materializes only after closing on an apartment.

2. you can't simply ask whether the deduction is factored in to real estate prices. you have to ask to what extent it is factored in to real estate prices. yes, prices would fall if the deduction were eliminated. but how much would they fall?

Of course its already discounted into the price. Which is why it absolutely needs to be included in any rent vs. buy math. If you don't include it, and you always insisted we don't, its akin to repricing properties as if the government abolished the interest tax deduction.

Lets turn this around: you've insisted all this time that the mortgage interest deduction doesn't matter. That banks don't use it when they figure out PITI, so we can't use it either. Yet now you agree that if it disappears, property prices will react extremely harshly in response. Which is it? Do they matter or not? You can't have it both ways.

At least try to be consistent in your blatant lie shill'ing.

No happyrenter, not simplistic at all.

1. If that is so (and it is) then when you do a buy vs. rent calculation you can't factor it back in, else you'd be counting it twice.

2. Your question two is an excellent one. I don't have the answer, but here seems to be one:

http://people.brandeis.edu/~cecchett/frbc96c.htm

I just HAD to look at tech_guy, see if he'd take the bait: "Of course its already discounted into the price. Which is why it absolutely needs to be included in any rent vs. buy math."

So it's already in the price, which is why you have to include it again.

My point exactly: you're counting it twice. Once in the price and again in the ratio.

Steve,

Aren't you counting it in the opposite direction? That is, you paid extra in order to get the deduction; thus, you need to actually GET the deduction (ie, factor it into your rent/buy analysis). Not factoring in the deduction would be the equivalent of your example: the government canceling the deduction. It would be paying for the deduction, and then not receiving it.

Stevejhx, you have it wrong. The price is higher BECAUSE of the deduction so you need to count it in the rent/buy analysis. To be perfectly honest you lost some credibility with me with your last point.

stevejhx, face it, you're wrong. Even happyrenter is taking my side of this argument. What next, are you going to say he's LICC also?

Its included in the price because its a very real benefit. Then when analyzing my monthly cashflow after paying that price, I need to continue to consider it because its still a very real benefit. Then, assuming the law doesn't change, I continue to include it in the price I sell at.

Think of it as a free gym in the building. It would push prices up a tad. Then I get to cancel my outside gym membership and save a bit of money every month. Do you yell at me that I'm double counting? No, I'm realizing the benefit that I already paid for. And, that benefit will still be there for whoever I sell to, so I get to keep it factored into the sell price.

http://www.entrepreneur.com/tradejournals/article/175523986.html

It would appear, happyrenter, that the answer, at least in 1970, was that property prices would have fallen rather dramatically: 17.1%.

And here is why tech_guy is wrong.

I buy a house for $100,000. At 6% interest, 80/20 30-year mortgage, my mortgage payments will be $479.64. Add $100 a month in property taxes and $100 a month in insurance. My total monthly payments are $679.64.

I can rent the same house for $100,000/12/12 a month, or $694.00 a month. For argument's sake, a 12x ratio. The payments are approximately the same, $679.64 vs. $694.00. But I have mortgage interest of about $82 a month (forget property taxes for now). I'm in the 28% tax bracket. That reduces my payment by $22.96 after tax, so my net total monthly payment is $656.68.

Eliminate the mortgage interest deduction, and my net payment goes up $22.96 a month. So in order for me to keep the same payment without the mortgage interest deduction, the price of the house would have to fall by about $4,600. That would make the price of the house not $100,000, but $95,400. That would make the new ratio about 11.5x annual rent.

So using the p/e method - which is the one I've been using - the mortgage interest deduction is already taken into account, because if you get rid of it, the ratio changes because the price of the house must change to keep the payment the same. Therefore, since it's already in that ratio, you can't add it in again.

IF, however, you use a formula that explicitly takes that deduction into account (imputed rent, for example), then it's different. But the p/e ratio IMPLICITLY takes it into account.

"So using the p/e method - which is the one I've been using"

...using wrongly. Which is why you're the only one using it.

You've still never acknowledged that the ratio will change drastically based on interest rates. That the 12x value was determined during a time when mortgage rates were much higher. Why is it that government policy changing the effective interest rate (through deductions) changes the ratio, but actual interest rate changes don't change the ratio?

You're a lying shill who knows better but posts lies anyway. I'm glad the other bears are starting to see this for themselves.

Sorry HR & UE, but look at the example. It fairly clearly explains the issue, and what the confusion is about.

The price of a house IS higher because you PAY for the mortgage interest deduction: it's not free. And you PAY what it's worth, no more, no less. You PAY for it because if you didn't get it, you'd pay less for your house. Take it away, and the value of your house must fall for you to keep the same after-tax payment, but RENT would remain the same. Therefore, the ratio would change.

There are two (actually more, but that's okay) ways of looking at this in terms of ratios:

1) The mortgage interest and all other deductions are implicitly included; and

2) The mortgage interest and all other deductions are explicitly included.

The 12x ratio falls under category #1: the deduction is implicit in the ratio. That's because, if you were to take the deduction away, in order to keep the after-tax payments the same, the price of the house would have to fall, which would lower the ratio.

The imputed rent / owners' equivalent rent models EXPLICITLY take all deductions into account. They are, therefore, more granular, but they will give you a different ratio.

So, when we discuss the p/e ratio, all deductions are assumed to be included in the price of the property. If we discuss other ratios, those deductions may be accounted for explicitly. But you can't have it both ways: in the first way you can't have a deduction implicitly and then add it explicitly, and in the second way you can't have a deduction explicitly and then assume that it is also implicit.

Apples and oranges.

steve has lost all credibility on this board ages ago. His new claim that you can't take into account the mortgage tax deduction when comparing rent v. ownership costs, because the purchase price is higher anyway due to the mortgage deduction, is ridiculous. How does anyone buy into his nonsense?

I think you're forgetting supply.

Imagine there was no mortgage deduction and then it was suddenly enacted into law.

Yes, prices would probably go up. But then builders would be incented to build and supply would go up.

Higher supply, and prices come down again.

"You've still never acknowledged that the ratio will change drastically based on interest rates."

I have acknowledged that the ratio will change based on interest rates, though not drastically. It is true that today interest rates are low, but credit is also very tight, which tend to offset each other. That is, even though money is relatively cheap, it's available to fewer people.

Also, disposable incomes in New York are falling. This will cause rents to fall (as they are). This will make property prices fall, regardless of the cost of credit.

"That the 12x value was determined during a time when mortgage rates were much higher."

No. It's a 15-year average, which includes interest rates FAR below where they are today. One more reason why the ratio went up so high.

"Why is it that government policy changing the effective interest rate (through deductions) changes the ratio, but actual interest rate changes don't change the ratio?"

I've always said they do.

"You're a lying shill who knows better but posts lies anyway."

There is the calculation. Call me all the names you want.

"I'm glad the other bears are starting to see this for themselves."

Are they?

Topper, that's an excellent point, but as you imply, it's a short-term phenomenon.

Oh, LICC! "because the purchase price is higher anyway due to the mortgage deduction, is ridiculous. How does anyone buy into his nonsense?"

So you mean to say that if the deduction were taken away, property prices would remain the same?

How could they, when that would increase monthly payments?

Hey steve, here's some bait for you to further show your incompetence:

I found a hypothetical purchase. I could rent it for $5000, or I can buy it with 0% down and my monthly payments are $5500. My accountant says I could save at least $1000/month on taxes if I buy, probably a lot more.

What's the smart move? I know you're going to dodge the question hopelessly, but other bears out there - force him to actually answer this hypothetical question. The correct answer is buy, but steve will insist the tax deduction must be ignored, so renting is clearly the right answer to that hypothetical question.

steve tries to manipulate all his examples with cherry-picked data and numbers, that is why he is called a lying shill.

Let's say you are comparing a $3500/month rental to a similar apartment priced at $700k. steve would tell you that the 12x ratio means you should only pay $432,000. This is ridiculous. Assume an 80/20 mortgage at 7% ($560,000). Let's also assume $1200 in monthly common charges and taxes. This would amount to roughly $5,200/month. steve would end the discussion there. But now let's look at the real world. With the mortgage and property tax deductions, your real after-tax monthly cost is more in the $3600 range.

It is this type of practical analysis for which steve has no response.

steve,

you're example is just not accurate, you are dodging and bringing up totally irrelevant points to cover up for a simply incorrect accounting method. a tax benefit is a benefit--in this case one that you pay for in advance. you seem to acknowledge that you pay for it advance, but then turn around and deny that you actually receive it.

tech_guy, as for your example, if only it were that simple! here's the problem: we have absolutely no idea what is going to happen to the value of your property. even with no down payment you have still taken on the risk of the entire price of the home. if the real estate market declines, you will lose money, tax savings or no. so we actually have no idea which will be the better move.

Learn to read steve. You are the king of misleading out-of-context statements. Anyone who read what I wrote above can see that I never implied that the mortgage deduction does not affect prices. However, it does affect the rent/own cost analysis, as any person with even moderate intelligence can understand.

Happyrenter: Bingo, that's it in a nutshell: We can never know the state of fututre RE markets:

"if only it were that simple! here's the problem: we have absolutely no idea what is going to happen to the value of your property. even with no down payment you have still taken on the risk of the entire price of the home. if the real estate market declines, you will lose money, tax savings or no. so we actually have no idea which will be the better move."

Happyrenter: Bingo, that's it in a nutshell: We can never know the state of future RE markets:

"if only it were that simple! here's the problem: we have absolutely no idea what is going to happen to the value of your property. even with no down payment you have still taken on the risk of the entire price of the home. if the real estate market declines, you will lose money, tax savings or no. so we actually have no idea which will be the better move."

happyrenter: Let me clarify my example by saying you also have a crystal ball which tells you that property values will remain static from now until you sell. Won't go up or down 1 penny. My point of keeping it that simple is to show that stevejhx's analysis chooses the *wrong* answer in even the simplest of situations.

This hasn't been asked before - steve gets his 12x value from this:

http://money.cnn.com/magazines/fortune/price_rent_ratios/

What's the explanation for why the 15 year price to rent ratio varies so greatly across different cities? Surely the rock solid universally accepted theory that steve has 100 academic papers to support should not be a localized phenomenon - it should be as universal as gravity. At least within the same country, where the same laws apply. Yet it varies from Pittsburgh at 10.6x, New York at 11.7x, all the way up to 10 cities above 20x, 5 above 25x!

Did you guys know Steve Hanley wrote a book?

Steve, post the link! It's called "Bushistotle"

LOLOLOLOL

anonymouss, why is that funny? he wrote a book, got it published, got it reviewed (somewhat favorably). good for him, no?

"in this case one that you pay for in advance. you seem to acknowledge that you pay for it advance, but then turn around and deny that you actually receive it."

No I don't deny that you actually receive it. I say you receive it, and you pay for it. I'm talking about the ratio. The naked ratio between rents and purchase prices. If you receive a 10% tax benefit for purchasing, then the price will go up until the monthly payments equal rents. If you take that benefit away, the price will go down until the monthly payments equal rents.

Which is why no one here gets it. You get a tax benefit, you pay for it with a higher price. You can compare the prices two ways:

1) All benefits are implicitly discounted into the price;

2) All benefits are explicitly calculated to obtain the price.

The 12x ratio is an implicit discount method. As such, you cannot then add any benefit back in, since it is the naked ratio between rents and purchase prices. Imputed rent and owners' equivalent rent, on the other hand, EXPLICITLY calculate all factors that go into deriving a price. Therefore, they must include ALL factors, and cannot assume that any is implicit.

"What's the explanation for why the 15 year price to rent ratio varies so greatly across different cities?"

Because in some regions PITI is 28%, in others it's 32%, in some regions income requires to rent are 30x monthly rent, in others (like New York) they are 40x monthly rent, in some regions incomes are higher, in others they are lower, in some regions there are low taxes, in other regions there are high taxes, in some regions there are subsidies to build rental properties, in other regions there is not, in some regions there is a shortage of rental properties, in other regions there is a surplus, in some regions there is rent regulations, in other regions there are none, in some regions it is culturally more acceptable to rent, in others it is culturally more acceptable to buy.

I could go on. Real estate is a local market.

"I found a hypothetical purchase. I could rent it for $5000, or I can buy it with 0% down and my monthly payments are $5500. My accountant says I could save at least $1000/month on taxes if I buy, probably a lot more."

Not enough information to answer the question. What is the purchase price of the house, the mortgage rate and term, taxes, insurance, tax bracket (I'll even humor you on that one), estimated future increase / decrease in real estate prices and rents?

"Which is why no one here gets it."

oh my

steve,

you're now stating a tautology that is very different from what you began the thread with. if you explicitly state "I am using a method for calculating real estate values that excludes tax deductions from rent/buy analysis," then yes, it cannot be debated that the mortgage deduction will have no impact on your calculation. that's not what you initially said.

Yup. They are seeking to explicitly include one element of a ratio that is already implicitly included in it. That is to account for it twice. But they insist on doing it.

Of course, steve does not address my example above, which shows that if you used the 12x ratio, your after-tax ownership costs would be significantly below rental costs. Just run a $3000 rent against the after-tax costs of a $432k purchase price (steve's 12X ratio cost) and see how silly the numbers are. Your monthly ownership costs would be more than 10% less than rental costs.

"that's not what you initially said."

Indirectly it is what I said, HR, and I said it that way on purpose, to bait LICC = tech_guy et al.

Of course the deduction is real, but it is illusory in the sense that it is implicit in the price of a property as it is a benefit we pay for.

If you want to determine the proper price for a property, then, it is not necessary to add that benefit back in, as it's already in the price. There is a general ratio - 12x in New York - called the p/e ratio that assumes all inputs are discounted into the price. Since it assumes that, it is not possible to add any benefits in explicitly, as they are implicit.

IF one were to choose a methodology that EXPLICITLY calculates benefits to derive a price, that's fine, the tax deduction would be added in explicitly. But such a methodology could not, then, assume that the mortgage tax deduction benefit is explicit, whereas the property tax deduction is implicit. Either everything is implicit or everything is explicit, but not both.

That's what this is about. When in NY we use the 12x ratio, that ratio implicitly includes all costs, benefits, and constraints. Use a different ratio you'll get a different number.

steve,

when you say in ny "we" use the 12x ratio, i think you are going to get a lot of argument. YOU use this ratio, and YOU insist that it is a ratio based on excluding the mortgage tax deduction from the rent/buy calculation. Fine, do that. And you are certainly right that a different ratio will yield different numbers.

when i bought my apartment, i certainly considered the mortgage deduction when comparing the benefits of owning versus renting. when i bought, it made sense to buy. i sold once it very clearly did not make sense to own--yes, using my numbers as i saw fit. given that i am an individual, and i am in a high tax bracket, and i only intend to purchase real estate to live in, i will certainly factor the mortgage deduction into any decision i make about buying v. renting.

Notice how steve cannot provide any numerical example to support his 12x theory.

"Let's say you are comparing a $3500/month rental to a similar apartment priced at $700k. steve would tell you that the 12x ratio means you should only pay $432,000. This is ridiculous. Assume an 80/20 mortgage at 7% ($560,000). Let's also assume $1200 in monthly common charges and taxes. This would amount to roughly $5,200/month. steve would end the discussion there. But now let's look at the real world. With the mortgage and property tax deductions, your real after-tax monthly cost is more in the $3600 range."

"which shows that if you used the 12x ratio, your after-tax ownership costs would be significantly below rental costs."

LICC, if you only include half the equation, you'll get twice the answer. Take your $140,000 down payment, lever it likewise to the maximum (2x principal) for a total investment of $420,000, make an 8% average return on it for a total income of $33,600, subtract $16,000 cost of funds for a total profit of $16,800, or $1,400 a month in foregone interest, deduct 28% tax on it for a net monthly income of about $1,008.

Subtract that from your $3,500 rent and you're actually paying $2,500 a month rent versus $3,600 in net payments if you buy.

So if you include just half the equation, voila! You'll get your answer.

"YOU use this ratio, and YOU insist that it is a ratio based on excluding the mortgage tax deduction from the rent/buy calculation."

No. That is a ratio calculated by Fortune magazine. Not by me.

I don't doubt what you're saying. I'm saying it's a different way of looking at it. It's a different ratio. It is EQUALLY valid, but the number will be different.

Let's say you can't decide between a Mercedes and a BMW. You can choose just to look at the ratio of the prices between the two, or you can make a detailed list of all the gadgets included in both cars, and then a subjective list of the externalities - you like BMW leather better, for example.

All of those ways are valid. If you take the aggregate - just looking at prices - and add it up for an entire market, you'll get a ratio. If you take all the micro elements of each car - the gadgets - you'll get an equally valid, though different, ratio. If you add in the externalities, ditto.

What I'm saying is that when the literature talks about the p/e ratio, it is the first of those ratios: just take the cars as a whole and compare them. Use the second ratio, where you account for every detail individually, you will get an equally valid, albeit different ratio. The point is you can't take the first ratio and then say, "Let me add just the benefit of the radio into it." Either you take it as a whole, or take it in its constituent parts. But not mix.

I did answer you, LICC. You only account for half the equation.

"when you say in ny "we" use the 12x ratio, i think you are going to get a lot of argument. YOU use this ratio, and YOU insist that it is a ratio based on excluding the mortgage tax deduction from the rent/buy calculation"

Yes.

NYTimes actually used 20x in its article on ratios (granted, includes houses). I've generally heard folks say 15x, but not 12x. Steve is the first.

Oh, and in terms of who I've heard from... my family has owned apartment buildings for a good 60 years...

"NYTimes actually used 20x in its article on ratios (granted, includes houses)."

I would reckon that that is not the p/e ratio. Find out what goes into it. I bet it is owners' equivalent rent, which is about 20x. But it is calculated differently.

no, sorry... try again.

steve, the opportunity costs of your down payment is offset by the rise in value of your asset, the property you own. The value of either can go up or down. This is yet another concept you fail to understand. Just looking at the risky assumptions you had to make to counter the numbers I presented shows how you are desperately losing the argument.

"no, sorry... try again."

Tell me what goes into their ratio. How do they calculate it? Over what time period?

Look at their price-rent slide rule tool thing. It EXPLICITLY includes many factors. That is not the p/e ratio of 12x.

Oh, and nyc - as of today my China investment is up 20% in 6 weeks.

Guess I made money, ha?

"the opportunity costs of your down payment is offset by the rise in value of your asset"

And what if it falls in value?

"Just looking at the risky assumptions you had to make to counter the numbers I presented shows how you are desperately losing the argument."

Actually, they're really conservative. But you do one with the opportunity cost included. You will see that it offsets the tax benefit.

If this is a game of who can type more, I concede to steve. For those who care about facts, I think its pretty clear to everyone (even the bears) that steve has NO idea what he's talking about.

Remember folks, this is the guy who rationalized his "Dow headed towards 6500" as being a correct call because the Dow went downwards... he said "towards 6500", not necessarily hitting it. As if the calls of "towards 6500" and "towards 1000" are really the same call - just saying it'll go down a bit tomorrow.

Intellectual honesty is something steve doesn't even understand, nevermind exhibit. With that, I'm off - Happy Thanksgiving everyone! My prediction: Dow towards 1 million by end of year!

I didn't think you could put up a calculation, t_g.

As with your alter-ego, you just say what you want, and provide no data, theory, or calculation.

steve, once again you show your roots. leave it to the guy who wasted 5+ years in college for a masters in spanish to enlighten all on the rigors of what he calls a "proof". leave numbers and logic to people who understand them and go back to attending those tacos steve.

you owned yourself with your circular logic and are now trying desperately to claw yourself out of this hole you dug with a change in subject. when i read your initial post i was simply dumbfounded, but after reading up the follow up posts, I couldn't help but laugh uncontrollably.

admit it, tech_guy has this round in the bag.

steve, you asked for a calculation? I stopped reading. I gave you one here, reread it:

http://www.streeteasy.com/nyc/talk/discussion/6009-same-apartment-for-rent-and-for-sale

And yes, this thread will join my bookmarks for future linking :)

Steve, maybe if you ever took a hard science class or math class or logic class beyond 101-level (at a shitty school) you'd better understand what a proof is and what is required to create a proof.

stevejhx
about 5 hours ago
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I can rent the same house for $100,000/12/12 a month, or $694.00 a month. For argument's sake, a 12x ratio.

a 12x ratio implies a 8 1/3rd% rate of return on real estate. This is pretty high in today's interest environment.

But a nice anachronistic theory.

8 1/3rd% yield, pre-inflation or GDP growth if property values only grow in line with the economy.

People try to argue that they need to keep a mortgage rather than pay it down in order to shield their income. There are other investment choices (triple tax free investments) and they can build wealth. It is one thing if people really to spend the money wisely somewhere else, but as we have seen, most people let the liquid assets burn a hole in their pockets and buy stuff...

Steve, why do you include insurance costs for ownership but ignore insurance costs of renting? Rental insurance is admittedly less, but it seems unbalanced that you cherry pick expenses of owning in this way.

"leave it to the guy who wasted 5+ years in college for a masters in spanish"

18 months. Ridicule if you like - you take my masters degree tomorrow & I'll take yours, and see who does better.

The Spanish department at Columbia is the hardest department in the entire university to get a PhD - 12 years. In fact, they had to reduce the difficulty of it because it took so long.

So ridicule away.

"8 1/3rd% rate of return on real estate. This is pretty high in today's interest environment."

So you're arguing that it's even lower?

"why do you include insurance costs for ownership but ignore insurance costs of renting?"

Include it's. Mine is $800 a year, and I have a $25,000 dining room table, and all custom-made furniture. It is minuscule.

"I gave you one here"

Copy it for us. Humor us.

stevejhx "The Spanish department at Columbia is the hardest department in the entire university to get a PhD - 12 years. In fact, they had to reduce the difficulty of it because it took so long."

Thanks for the misleading post. You didn't get your PhD. Might as well tell us how hard it is in medical school - you didn't do that either.

Your ability to issue bald faced deceptions is just amazing.

I still don't get why we talk about something as negligible as insurance here. Coop ins. for a 1 bedroom is nominally more than the $800 renters insurance you pay. Maybe $1100 or $1200. Why do you even bring it up? It's like including the gas bill. Complicated enough without muddying it up. I don't get why you do that Steve. It's like you always toss something in to keep the discussion from being to focused.

When steve's conclusions are shown to be incorrect and unintelligent, he tries to misdirect the conversation.

this thread in part restores my faith in the board

I don't think you guys understand. stevejhx can totally see Harvard from his apartment. Are you denying that Harvard is an excellent school? He's about to link 12 publications saying Harvard is great, and you haven't provided a SINGLE calculation showing Harvard sucks. How can you say stevejhx isn't smart without a single calculation to prove it?

everyone needs to chill out. it is my understanding that Steve is trained in economics (with honors!) and has been in the accounting/auditing/consulting field for years. he clearly has the training and exposure to put you all in check. for those of you interested, his history has been further dissected today at:
http://www.streeteasy.com/nyc/talk/discussion/6263-desperate-at-chelsea-stratus

I don't really understand we everyone is so worked up. i went to Harvard (so much for seeing it from my house) and Cambridge, I made a million dollars on a game show, I work at one of the top hedge funds in the world, i speak five languages, i am a pianist, i play bridge, and i once rode a bike across europe. does any of this make me an expert in new york city real estate?

this is an anonymous blog. anyone can say anything he wants about himself. why not just take people's opinions and theories and face value and move on? credentials are obviously irrelevant in an anonymous forum.

Steve lovers check
http://www.streeteasy.com/nyc/talk/discussion/6352-stearn-bear-seen-chaseing-ny-citi-and-fore-closing

steve finally did acknowledge the mortgage interest deduction here:

http://www.streeteasy.com/nyc/talk/discussion/6359-where-are-all-the-idiots-who-made-the-2007-doomsday-predictions-

Yet still claims he was right all this time. Entertainment this good shouldn't be free!

"steve finally did acknowledge the mortgage interest deduction here"

Oh tech_guy = LICC! Silly you(s)! I've always said that there was a mortgage interest deduction. How could I not? What I have always said is that it is not worth your marginal rate, but rather your effective rate. And I've demonstrated it, and shown how it is already discounted into the value of properties. And why the p/e ratio works. And so on and so forth.

You pick and choose which deductions you apply when and you can get any answer you want. As you do.

Entertainment this good shouldn't be free!

steve, no one is buying the BS you're trying to push here. Keep at it thought, because you keep showing everyone your lack of brainpower.

Yes, LICC, back to insults because you don't have a reasonable answer.

Insults are the only thing left when you redefine English to make it sound like you're right. Nobody else but you thinks you were right all along on mortgage rates. Even fellow super-bears think you were pretty stupid on that debate. But if you're the type to claim you were right about "Dow to 6500" simply because there was a single down day afterwards, of course you're going to think you're right about everything, even the dumbest of things.

Why bother arguing about real estate prices? No matter what happens you'll say you were right about your 50% decline call. Some property somewhere went down at least a dollar, and that's "towards negative 50%", so clearly your call was right.

Pathetic. No wonder your job is retyping other people's work - nobody buys your original work.

I and others have provided reasonable answers time and again. steve responds with nonsense and disingenuous blather. At that point all I'm doing is calling him out on it.

Ignoring comment by LICComment

Ignoring comment by tech_guy.

Creepy when he starts talking to himself again.

stevejhx wrote: "What I have always said is that it is not worth your marginal rate, but rather your effective rate"

Actually, this is completely false. I've clearly demonstrated that even in the most extreme possible case (in your favor), it's more accurate to use your marginal rate than your effective rate. In *most* cases using your marginal rate will be 100% accurate because in most cases your deductions won't move between tax brackets. It's just that every time people show actual numbers you stop responding so you can go declare victory elsewhere.

I suppose if you redefine "effective rate" as "blended rate of taxation for the dollars being deducted" as opposed to "blended rate of taxation for the dollars being taxed", you'd be right. But no one actually uses the term "effective rate" this way.

(On topic aside: if we're talking about the 12x multiplier because we're expecting a regression to mean, then it's useful to see whether the 12x multiplier actually applies to pre- or post-deduction p[rices historically rather than arguing about whether we should take it into account or not in our computations--just do the computations the same way as the calculation to determine the ratio in the first place. If we're talking about the 12x multiplier because we think it has some other magical meaning, it's probably a waste of time.)

[stevejhx: So using the p/e method - which is the one I've been using - the mortgage interest deduction is already taken into account, because if you get rid of it, the ratio changes because the price of the house must change to keep the payment the same. Therefore, since it's already in that ratio, you can't add it in again.]

Steve, the P/E ratio does not change. In your $100k house P/E example, you should be adding the tax benefit to the monthly payment (theoretically rent) to arrive at monthly earnings. Then, apply your assumed multiple to get the fair price. Should the tax benefit go away, your earnings would be reduced, but the P/E ratio would remain unchanged. This is why the price would drop. P/E ratio does not change, Price / Rent ratio does.

[stevejhx: The price of a house IS higher because you PAY for the mortgage interest deduction: it's not free. And you PAY what it's worth, no more, no less. You PAY for it because if you didn't get it, you'd pay less for your house. Take it away, and the value of your house must fall for you to keep the same after-tax payment, but RENT would remain the same. Therefore, the ratio would change.]

Yes, exactly - the price / rent ratio would change, and this is what everyone has been saying all along - the monthly payment / rent ratio can be higher than 1x. Because earnings do not equal rent. There are real tax benefits, including interest tax and the $250k capital gains break that you don't receive on alternative investments...

> Oh, and nyc - as of today my China investment is up 20% in 6 weeks.
> Guess I made money, ha?

So, you made back a small fraction of what you lost on the dow moves? And your 20% is off a smaller base.

Hell, the dow is up 16% since you told everyone to sell.

You are the guy who loses $1k in black jack and then brags about the quarter he made in the slots...

"Hell, the dow is up 16% since you told everyone to sell."

And' it's down 450 points today, and my be up or down tomorrow. Pick your start and end dates, you'll get whatever result you want.

"It's just that every time people show actual numbers you stop responding so you can go declare victory elsewhere."

Absolutely not. What you want to do is to pick and choose the order in which you apply your deductions. Unfortunately, all deductions are taken at one, so they must be counted as a whole. You get to your marginal rate because you have x amount of income and y amount of deductions (etc.). So you assume you buy your house last.

But you get your tax deduction in January - when your income and deductions are low - just as you do in December - when your income and deductions are high. You assume that the mortgage tax deduction is applied at the end, but it's not. That's why you need to use the average amount, and that's why economists (not real estate agent) use the effective rate.

"the P/E ratio does not change," then: "Yes, exactly - the price / rent ratio would change"

So it both changes and does not change? The p/e ratio is the price/rent ratio; same thing.

stevejhx: p/e ratio is the price/rent ratio; same thing.

No, it's not. I explained this.

It is amazing how steve can maintain an absolute insistence on his embarrassingly incorrect analysis of the mortgage interest deduction. It is at the point where he is just weird.

"But you get your tax deduction in January - when your income and deductions are low - just as you do in December - when your income and deductions are high. You assume that the mortgage tax deduction is applied at the end, but it's not. That's why you need to use the average amount, and that's why economists (not real estate agent) use the effective rate."

Its these fundamental flaws in stevejhx's understanding of the basics of life that keep me entertained :) You don't get the deduction in January. You don't get it in December either. You get it April 15, when you calculate the entire year's income, and the entire year's deductions.

Everything else is just estimated payments. It doesn't matter how you calculate them so long as they add up to close to the actual tax burden on April 15.

stevejhx wrote: "Absolutely not. What you want to do is to pick and choose the order in which you apply your deductions. Unfortunately, all deductions are taken at one, so they must be counted as a whole. You get to your marginal rate because you have x amount of income and y amount of deductions (etc.). So you assume you buy your house last."

Actually, in my analysis (which you apparently didn't bother to read, so certain are you that you're right) what I did is apply the mortgage deduction last (meaning that the lowest tax rate would apply to it) and even in a situation where you were only one dollar into the tax bracket with the biggest difference between it and the next lower one, it was STILL more accurate to use the marginal tax rate than the effective tax rate, and that's the scenario that most favors your interpretation. In reality (as I have repeated many times) all of your deductions combined don't move you between tax brackets, so using your marginal tax rate is 100% accurate regardless of the order you apply deductions in.

Why don't you try this, Steve? In the past, I provided some posts with actual numbers (income, deductions, tax due) to substantiate my position. You just keep making inane arguments with no support. If you think you're right, why don't you show some sort of scenario in which your effective rate is more reflective of the tax reduction than the marginal rate. Then you'd at least have some credibility.

Also, if you change your withholding, you get the deduction with each paycheck. No need to wait until December, or January, or April 15. Just do some rudimentary tax planning in advance and you'll be okay. I can see how if you constantly under-compute the benefits of your deductions that it would seem like you didn't get them until your refund check shows up at the end of the year, though.

> And' it's down 450 points today, and my be up or down tomorrow. Pick your start and end dates,
> you'll get whatever result you want.

They're not my picks, they are yours. I'm just picking the days you made your calls... if losing money is the result you want, I guess you got it... well done.

Right now, looks like Steve called the bottom... with a "sell" call. Nice!

Jordyn, of course the marginal tax rate is the correct rate to use. The decision is to buy or rent, holding all else equal. What would your cash flows be if you rented? What would they be if you bought? The true difference can only be calculated correctly if you use the marginal rate. Your taxable income is the same regardless of the order of your deductions. Despite what Steve says, any economist would tell you that marginal is the correct rate to use.

"Why don't you try this, Steve?"

I have.

"all of your deductions combined don't move you between tax brackets"

If that were so, your effective rate would be equal to your marginal rate, and it is not.

"You just keep making inane arguments with no support."

I gave my numbers - I don't see where you put yours. I read your argument - it just makes no sense.

I don't doubt that every next deduction is applied at the marginal rate. But the entire effect on your taxes is not at the marginal rate - it MUST be at the effective rate (which changes).

Again, you have $10,000 in income. 2 tax brackets: 25% and 50%. The 25% tax bracket is from $0 to $8,000. The 50% tax bracket is from $8,001 and up.

You have 2 tax deductions: $2,000 for property tax, and $2,000 for mortgage interest. How much is each deduction worth individually?

"They're not my picks, they are yours."

No - you insist that the world has ended today, and the stock market will never be higher or lower than this. It is the same criticism I had of malraux and the "Dow 11,000" scenario - so what if it didn't happen in 2007? It happened - and much worse - in 2008.

Even though I shouldn't be, I am still surprised that steve is too slow to understand what an "effective" rate is. steve is a special combination of arrogance with lack of intelligence. He's probably good at being a parrot, repeating things that he hears or reads, but he has no capability to analyze and correctly apply concepts.

Stevejhx: Again, you have $10,000 in income. 2 tax brackets: 25% and 50%. The 25% tax bracket is from $0 to $8,000. The 50% tax bracket is from $8,001 and up. You have 2 tax deductions: $2,000 for property tax, and $2,000 for mortgage interest. How much is each deduction worth individually?

Each deduction is worth $1,000 alone. Because, holding all else equal, your marginal tax rate is 50%. Combined, they are worth $1,500. In this case, your marginal tax rate is 37.5%. Apply either one first, then the other. Hell, apply both of them before any of your other deductions. You can't deny that the marginal effect of including them vs excluding them saves you $1,500, holding everything else equal.

Steve: my previous analysis can be found in this thread: http://www.streeteasy.com/nyc/talk/discussion/3764-jpmorgan-cutting-55-of-bear-staff?page=1

You'll see that I use real numbers from the IRS instead of just making up tax brackets. If you want to use real numbers that make your point, feel free, but using numbers that have no relationship with reality isn't really proving anything other than that you can make something up.

However, just to address one point:

""all of your deductions combined don't move you between tax brackets"

If that were so, your effective rate would be equal to your marginal rate, and it is not."

No. The reason why your effective rate isn't equal to your marginal rate is that you had a lot of income in lower tax brackets that was taxed at different rates. The fact that your deductions come off at your marginal rate doesn't change the fact that your first $8,000-ish dollars was taxed at 10%.

To keep things simple for you, and sticking with the numbers you invented. Let's say you have $10,000 in income with your same two tax brackets. You have 2 tax deductions: $1,000 for property tax and $1,000 for mortgage interest.

How much does your mortgage interest reduce your taxes if you apply the deduction FIRST? $500
How much does your mortgage interest reduce your taxes if you apply the deduction SECOND? $500
What? How can that be? How is it the same? Because the sum of your deductions doesn't move you between brackets. For most people, this will be true.
You'll also notice in this scenario that the amount the taxes are reduced is exactly equal to the marginal tax rate of 50%, not the effective tax rate of 33%.

jordyn picked apart all of steve's mistakes and inaccuracies in the jpmorgan thread. I've done it numerous other times.
steve, why are you so stubbornly foolish that you can't admit that you don't know what you are talking about?

> "They're not my picks, they are yours."
> No - you insist that the world has ended today,

No, I didn't... just noticing that you've been wrong EVERY SINGLE day since then...

> and the stock
> market will never be higher or lower than this.

I'm sure it will be higher AND lower, but you still made the wrong call.

Then denied it...

"The fact that your deductions come off at your marginal rate doesn't change the fact that your first $8,000-ish dollars was taxed at 10%."

Who ever said that they did?

"You'll also notice in this scenario that the amount the taxes are reduced is exactly equal to the marginal tax rate of 50%, not the effective tax rate of 33%."

Regardless of your math, no one doubts what your next marginal deduction comes at. Add a 3rd $1,000 deduction, however, and it comes off at the 25% tax rate. And since all 3 are taken at the same time, their effect must be calculated at the same time, not in the order you choose.

Steve - Let's go with your example. "Again, you have $10,000 in income. 2 tax brackets: 25% and 50%. The 25% tax bracket is from $0 to $8,000. The 50% tax bracket is from $8,001 and up. You have 2 tax deductions: $2,000 for property tax, and $2,000 for mortgage interest. "

Prior to the deduction, you have $10,000 in income and $3,000 in taxes (25% of $8,000 + 50% of $2,000). Your effective tax rate is 30%.

Now, you have $4,000 in deductions. Applying your 30% effective rate gets you $1,200 in savings, when in reality, the savings is $1,500 (50% of $2,000 + 25% of $2,000). The marginal tax rate on your combined tax deductions is 37% ($1,500/$4,000), and the effective tax rate for your total income is 25%. Therefore, applying the effective tax rate (either before or after the deductions) is JUST PLAIN WRONG.

this is the first time i have ever looked on these boards because i have a job and i cant be online all day reading let alone actually writing but i found a few minutes because i can't believe the BS i am reading. The deduction is not factored in as there are many different scenarios that go into mortgage interest deductions. Firstly, not everyone gets a mortgage deduction. If you do not itemize and your interest does not exceed the standard deduction then guess what? no benefit. if you make over a certain amount a year then you get hit with the alternative minimum tax and guess what? No benefit as your deduction may be eliminated. and of course, if you own an apt over a million dollars, which the majority are, any amount over said milloion cannot be deducted so again little or no benefit. it's obvious none of you make anything close to what it would take to get AMT'd (over 120K approx) so my guess is none of you have real jobs. stevejhx, you are well spoken but so is my hipster waiter in brooklyn. could it be you're one in the same?? hmmm

That was a dumb comment by oneoff. AMT does not reduce the mortgage deduction. Who in NYC making enough money to buy a condo would use the standard deduction? State and local taxes alone would cause just about everyone to itemize. Try to know what you are talking about before you comment, thanks.

Steve wrote: "Regardless of your math, no one doubts what your next marginal deduction comes at. Add a 3rd $1,000 deduction, however, and it comes off at the 25% tax rate. And since all 3 are taken at the same time, their effect must be calculated at the same time, not in the order you choose."

Steve, can you not read?

1) I AM APPLYING THE MORTGAGE DEDUCTION LAST IN ALL OF MY EXAMPLES. That means it gets the least favorable tax treatment. The "order I choose" is the order that most favors your argument, and yet the math still shows the marginal tax rate is the more accurate choice.

2) I HAVE ALREADY RESPONDED TO THE POINT YOU ARE TRYING TO MAKE. Even in a contrived example where essentially all dollars go into the lower tax bracket (so if you started with $8,001 in income in our example), using the marginal rate would STILL BE MORE ACCURATE than using the effective rate. So your suggestion is NEVER better.

3) PLEASE PROVIDE A REAL-WORLD EXAMPLE THAT DEMONSTRATES THAT EFFECTIVE RATE WOULD EVER BE MORE ACCURATE if you are going to continue making this absurd claim. As buster notes, even by your own (made up) example, your idea of using effective rate is wrong.

OMG steve, this thread is pathetic. Have you no shame?

JuiceMan, overnight LIBOR is at 1.09%.

jordyn, I don't see your math & I'm not searching through a thread to find it. Repost it if you want me to respond.

buster! "You have 2 tax deductions: $2,000 for property tax, and $2,000 for mortgage interest."

That's not the question. The question is: which deduction is applied at which rate?

oneoffreply, mostly okay, but mortgage interest is not subject to AMT.

"it's obvious none of you make anything close to what it would take to get AMT'd"

Actually, I pay it every year.

Sorry guys, I'm coming in late, but, please clarify: I'm subject to AMT, so how does that affect mtg & RE tax deduction?
I know I can't deduct mtg interest if my mtg exceeds $1 mil.
Thanks.

stevejhx - no, the original question is whether or not you need to take the mortgage interest deduction into account. You tried to prove that you don't using the P/E theory. Your analysis was flawed, and you were proved incorrect.

Then, the question became whether or not you use the marginal tax rate or the effective rate. You claimed you use the effective rate. With your example, I proved the effective rate yields the wrong answer. You tried to find fault with Jordyn's analysis, and he ended up proving you incorrect.

Now you are trying to evade acknowledging that you are wrong on both points by changing the question to "which deduction is applied at which rate?" I aloready answered that question. As I said before, the marginal tax rate for either deduction alone is 50%. However, combined, the marginal tax rate for the deductions is 37.5% ($1,5000/$4,000). It really doesn't even matter when you apply them because all that matters is your taxable income with the real estate deductions vs. without them. That is the marginal change, not each individual deduction on it's own. At any rate, the real point is that the $1,500 in tax savings cannot be derived using the effective tax rate (using the effective tax rate, you get $1,200 in savings).

I find it amusing that you claim to admit when you are incorrect, and yet...

Hey, buster,
Could ya help a brother out: How does AMT affect RE tax & Mtg deduction? Just a quick answer or could you point me to a web site? I'd ask my acctnt, but can't stand talking to him.
Thank you

dwell,

Mortgage interest on a primary home is still deductible under the AMT but you are screwed on the real estate taxes.

Dwell, mortgage interest is one of the few deductions allowed under the AMT. I think you can't deduct state/local RE tax.

"Your analysis was flawed, and you were proved incorrect."

No. Absolutely not. The mortgage interest deduction is included in the 12x ratio. Eliminate it, the ratio changes, because rent stays the same.

"I proved the effective rate yields the wrong answer."

No you didn't. I'm waiting to see your numbers reproduced.

"That is the marginal change, not each individual deduction on it's own."

Wrong, by your own logic. The marginal change is the change for every next deduction. But total deductions is the area under the curve. That's what matters.

I find it amusing that you claim to admit when you are incorrect, and yet...

"I think you can't deduct state/local RE tax."

You're making all these BOLD CLAIMS, and you only "think"? State, local income tax, property tax DEDUCTIONS are phased out under AMT to the phase-out limit, then they are phased back in.

For someone, buster, who has all the answers, you seem pretty ignorant to me.

stevejhx said: Yes I've heard all the claims about the benefits of the mortgage interest deduction, and how you have to add that benefit back in to get a 100x annual rent multiple or whatever to justify today's prices.
But it's not true. The mortgage interest deduction is already discounted into the price. Proof:

Yes, this is SOOO STUPID. Of course the mortgage interest deduction is discounted [sic] into the price.
->Interest rates affect price. It doesn't take a genius to understand that. So if the interest rate is 6%, you get one price on real estate. If the interest rate is 6% and you save taxes so it is approx 4%, you get another (higher) price on real estate.
How is an entire discussion topic dedicated to what anyone in the real estate industry (no, I'm not saying just brokers) knows? Jeez

Thanks Modern & Buster. I should move myself off shore.

Steve, I'm not going to clutter up this thread with a lengthy analysis that you can find by typing Control-F and searching on the other thread. Hint: it's on the first page.

Since you just ignored the analysis last time, I'm unsurprised you're trying to avoid responding to them again this time.

jordyn, you're the first person I've ever heard of worried about "cluttering" a thread.

Put up your numbers - the ones you want me to look at - and I'll look at them.

I'm not avoiding anything, just want to be certain.

"How is an entire discussion topic dedicated to what anyone in the real estate industry (no, I'm not saying just brokers) knows?"

Because what they know and what they want you to think are two entirely different things. Sort of like, "Buy now, or be priced out forever!"

Until prices collapse.

EVERYTHING is discounted into the price. It is an economic definition.

stevejhx: "For someone, buster, who has all the answers, you seem pretty ignorant to me."

I never claimed to be a tax expert, which is why I prefaced my AMT answer with "I think." I have an accountant, and haven't had to deal with AMT for quite some time, fortunately, so forgive me for responding to a question specifically directed at me... I do, however, have a slight bit of experience with finance which is why I know your explanation of the ratio is incredibly wrong. Think of a P/E ratio for a company. Corporate earnings include both interest paid and the provided tax shield. Say the government eliminates the tax shield on interest - market cap changes, but not because the P/E ratio changes, but rather because the tax benefit is gone and earnings decrease. It's the same for your apartment scenario. You have to include the tax benefit in your apartment "earnings." Earnings are not just rent. In your scenario, what has fundamentally changed the P/E ratio? Nothing. Earnings changed. If you don't understand this, you are hopeless. Misunderstanding a concept is forgiveable, but selective ignorance is completely absurd.

stevejhx: "No you didn't. I'm waiting to see your numbers reproduced."
Ummmmm... ok...
Steve - Let's go with your example. "Again, you have $10,000 in income. 2 tax brackets: 25% and 50%. The 25% tax bracket is from $0 to $8,000. The 50% tax bracket is from $8,001 and up. You have 2 tax deductions: $2,000 for property tax, and $2,000 for mortgage interest. "

Prior to the deduction, you have $10,000 in income and $3,000 in taxes (25% of $8,000 + 50% of $2,000). Your effective tax rate is 30%.

Now, you have $4,000 in deductions. Applying your 30% effective rate gets you $1,200 in savings, when in reality, the savings is $1,500 (50% of $2,000 + 25% of $2,000). The marginal tax rate on your combined tax deductions is 37% ($1,500/$4,000), and the effective tax rate for your total income is 25%. Therefore, applying the effective tax rate (either before or after the deductions) is JUST PLAIN WRONG.

At least we can all take solace in the fact that Steve *knows* he is wrong, whether he wants to admit it or not.

Here is jordyn's example - using actual tax rates instead of steve's made-up nonsense. How many different ways can people show the stupidity of steve's conclusions?:

Steve, let's demonstrate something with actual number so you can see how silly it is to use effective tax rate. I'll do two scenarios, including one that is most favorable to your position.

For simplicity's sake, let's say you're single, your AGI is $250K and you have $20,000 in deductions other than your mortgage payment. (I'm ignoring AMT, but also ignoring state and local taxes, once again for simplicity's sake.) You'd be in the 33% federal tax bracket, but you'd owe $61,651 in taxes so your effective tax rate would be 24.6%. Now you get a $35,664 mortgage tax deduction. This lowers your taxable income from $230K to $194,336 and lowers your tax due to $49,882. The $11,769 decrease in your taxes is exactly 33% (your marginal tax rate) of your mortgage interest. This doesn't "favor" your mortgage deduction, it treats it identically to all of your other deductions, which also get the same tax treatment. We can add on about another $30,000 worth of deductions before this matters, and I picked an AGI about halfway into the bracket.

However, let's compute this in the way that is most favorable to you. Let's say your AGI is $184,551 with the same $20,000 of non-mortgage deductions, which puts you $1 into the 33% bracket. You owe $40,053 in taxes, making your effective tax rate 21.7%. Now you add the $35,664 mortgage deduction, which reduces your tax owed to $30,067. In this case, essentially all of the effect of the deduction is in the 28% bracket. Even in this scenario, where you would otherwise be exactly on the border of the two tax brackets with the largest change in rates (i.e., the scenario that most favors the point you're trying to make), using your marginal rate gives a result that is $1783 off. Using your approach of using effective tax rate, you'd end up with an answer that is $2247 off. So, in the best possible scenario for you, using marginal tax rates is still considerably more accurate than using effective tax rates. As demonstrated above, in many cases using marginal rates will give exactly the right answer; unless you earn less than $8,000 or your tax deduction eradicates your income entirely, using effective tax rate NEVER provides the exact answer.

"I do, however, have a slight bit of experience with finance which is why I know your explanation of the ratio is incredibly wrong."

Apparently not.

"Steve - Let's go with your example."

No. Your effective rate CHANGES with new income and new deductions, or the elimination of either or both. So it can move, say, from 20% to 25%, or the other way around. That is what the total value of all your deductions is worth at your income level.

That seems pretty obvious to me and to every economist on the face of the earth who measures the effect of tax policies.

Think of it this way: your marginal cost for producing a widget is $1. The total cost for producing 100 widgets is $500. You produce 101 widgets, your total cost is $501. It cost your $4.96 to produce each widget, not $101, the cost of the last widget.

Tax brackets work the same way, but inversely since they rise with income. You need to determine how much it costs you to generate all your deductions. That is not at the margin.