Continuing my series on tax expenditures, I want to discuss an obscure one: the imputed rent that homeowners get from living in their own homes.

At first glance, the idea that this constitutes any form of income probably strikes most people as bizarre. But a little thought shows that there are many forms of income that don’t take the form of monetary payments. I discussed one previously, the exclusion for employer-provided health insurance. Clearly, it is a form of income that workers value but do not pay taxes on because a specific exception has been made in the tax law.

The exclusion for imputed rent is of a different nature. It is untaxed simply because of long practice, not because Congress or the Internal Revenue Service ever said so, although a 1934 Supreme Court case, Helvering v. Independent Life Insurance Co., suggested that a tax on imputed rent might be considered a “direct tax” requiring apportionment.

To see why imputed rent is a real form of income, consider two homeowners living in identical houses. Suppose they trade houses, each living in the other’s. They now pay rent to each other because the other is now the other’s landlord. If they pay identical rent, it would appear that it all cancels out, except that each now has rental income to report on her taxes.

In principle, that rental income is there even when one lives in one’s own home. Homeowners simply pay it to themselves though in this case, it does not give rise to taxable income.

In effect, homeowners wear two hats – consumers and investors. As consumers, they pay rent just as those who live in rental apartments do. As investors, they are landlords who receive that rent from themselves.

Of course, a key difference is that those who are pure investors get certain deductions denied to homeowners. They can depreciate or write off a portion of the value of a dwelling for wear and tear and obsolescence, as well as routine maintenance.

There is no reason why this treatment could not be extended to homeowners to equalize the tax treatment between different types of housing. In return for paying taxes on imputed rent, it would be perfectly reasonable for homeowners to get depreciation and a write-off for reasonable upkeep – painting, repairs and other necessary costs to maintain livability and structural integrity. And, of course, mortgage interest and property taxes would remain deductible. New appliances, additions and improvements would be considered investments that would also be depreciable.

The Department of Commerce’s Bureau of Economic Analysis calculates imputed rent on an annual basis and includes it in personal income, which is a major component of the gross domestic product. The data is typically found in Table 7.12 of the national income and product accounts, which have not yet been updated for 2012. Last year, the B.E.A. calculated that net imputed rental income was $284 billion for 2011. That includes depreciation or capital consumption, but does not include an adjustment for routine maintenance, mortgage interest or property taxes, which should be deductible.

It’s important to note that this $284 billion figure for imputed rent represents the bulk of rental income attributed to people in the aggregate data for personal income. In 2011, total rental income, net of depreciation, was $409 billion, of which $126 billion was received in monetary form. The rest was imputed rent.

The Treasury Department calculates that the tax expenditure for imputed rent – the revenue that would be raised if it were taxable – will be $75 billion next year and $437 billion from 2014 to 2018. That makes it the fourth-largest tax expenditure (see Page 254 in the “Federal Receipts” section of the federal budget).

For some homeowners, everything would cancel out. Their imputed rental income would be offset by depreciation and maintenance expenses. Because mortgage interest and property taxes are deductible, they will not enter into the calculation. But many would be worse off.

The economists James Poterba and Todd Sinai have calculated the impact of treating homeowners as landlords. First, they calculated the user cost of housing under 2003 tax law. They estimated that homeowners paid 6 percent of their income for housing after taxes. But this figure varied a great deal depending on the age and income of the homeowner.

Treating homeowners as landlords unambiguously would have made everyone worse off on average, with the net user cost of housing rising 10 percent to 6.6 percent over all.

That is probably enough to kill the idea forever, but it is still worth thinking about because it would equalize the tax treatment of all investments, including in one’s own home, which would yield efficiency gains for the economy and improve fairness between owners and renters. The Organization for Economic Cooperation and Development recommends that its member countries tax imputed rent (see Page 16, “Housing and the Economy: Policies for Renovation”) for these reasons.

Calculating imputed rent on an individual basis would, of course, be complicated. But the Bureau of Labor Statistics calculates a “rental equivalent” cost of housing for homeowners in order to determine changes in the price of housing, putting owners and renters on the same footing.

Some formula based on this calculation might be extended to taxpayers. Or the law could simply assume some reasonable rate of return. According to the O.E.C.D., five of its member countries presently tax imputed rent (see Page 39, “Housing Markets and Structural Policies in OE.C.D. Countries“) – Iceland, Luxembourg, the Netherlands, Slovenia and Switzerland. We could perhaps adapt one of their methods.

The point of this discussion is not to recommend the taxation of imputed rent, which Congress is extremely unlikely ever to adopt. It is to show that the most complicated question in terms of tax reform has nothing to do with deductions and credits, as is commonly believed, but rather what is “income.”

For individuals with only wage income, the issue is simple. But as soon as investments enter the equation, the question becomes more complicated, and that includes investing in housing by buying a home to live in. I will have more to say about defining income for tax purposes in future posts.


Bruce Bartlett held senior policy roles in the Reagan and George H.W. Bush administrations and served on the staffs of Representatives Jack Kemp and Ron Paul. He is the author of “The Benefit and the Burden: Tax Reform – Why We Need It and What It Will Take.”