What exactly is the mortgage interest deduction?

13 Jan

While the cost of buying a home has risen dramatically in the last few years, a house still comes with a variety of benefits over renting. One of the biggest advantages is the fact that you can use the mortgage interest deduction to help lower your tax bill.

However, the IRS rules that impact the mortgage interest deduction can be complicated so we thought it might be helpful to put together a brief overview of the deduction and how you can get the most benefits from the deduction.

What exactly is the mortgage interest deduction?

If your home has a mortgage on it, the mortgage interest deduction allows you to reduce your taxable income by the interest amount you paid on the mortgage loan over the last year. You may also be able to deduct other mortgage related expenses such as mortgage insurance premiums as well as any mortgage points. 

This deduction only applies to the interest you have paid on the mortgage, it doesn’t apply to the loan principal. In order to claim this deduction, you must itemize your deductions so you cannot file an EZ form or take the standard deduction. While this can be a bit more complicated and take some additional time, in most cases, the savings will be well worth the effort.

While this deduction has existed for over 100 years, the rules regarding it as well as the deduction limits have changed over the years.

Deduction limit for mortgage interest 

According to the current rules, if your home was purchased before Dec. 16, 2017, you are allowed to deduct the interest on the first $1 million in mortgage debt. If you are married but filing separately your deduction is capped at $500,000.

If your mortgage originated after the December 2017 date, your deduction limit is capped at 

$750,000 or $375,000 if you are married filing separately.

The mortgage interest deduction for the 2021 tax season

In order to claim the mortgage interest deduction this tax season (or any tax season for that matter), you will need to itemize all of your deductions and file a Schedule A Form 1040.

Before you fill out the entire Schedule A form it is always a good idea to make sure using this deduction makes financial sense for your particular situation, instead of using the standard deduction authorized by the IRS.

The standard deduction amount for the 2021 tax season is $12,550 if you are filing singly or $25,100 for married taxpayers who file jointly. The standard deduction will climb to $12,950 for single filers and $25,900 for married joint filers in 2022. If your deductions, including your mortgage interest deduction, exceed that amount, it makes sense to itemize your deductions. If your total comes in below the standard deduction amount, it may be best to take the standard deduction and use a simpler form. 

If you are unsure whether or not the mortgage interest deduction is the best choice, you may want to consult a tax professional.

What the IRS considers mortgage interest?

The IRS considers “mortgage interest” to be any interest that accrues from any loan that is secured by your primary or secondary home. Here is a quick rundown of the various costs and fees that can be deducted:

  • Interest on your primary home: You can deduct the interest you pay on your mortgage for your primary home. The home must have sleeping, cooking and eating facilities to qualify and can be a house condo, co-op, mobile home, boat or even a recreational vehicle.
  • Interest on a second home: As long as you don’t rent it out too much, you can often deduct the interest on a second home. If you do rent it out, you will need to use it for your personal use for more than 14 days a year or more than 10 percent of the time it is rented out, whichever is longer, to qualify for the deduction. 
  • Mortgage insurance premiums: Current rules allow you to deduct your mortgage insurance premiums as long as your adjusted gross income (AGI) is less than $109,000 as a married couple or $54,500 if you are filing individually. If your AGI is above these caps, you cannot deduct your mortgage insurance premiums. 
  • Late payment fees: If you are charged a late fee on your mortgage, you may be able to deduct the late fee amount.
  • Prepayment penalties: Many mortgages have a fee if you pay it off early, you can usually deduct this amount if you are penalized for paying off your mortgage. 
  • Points: If you originated a mortgage this year and paid points to lower your interest rate, you can often deduct the amount you paid for the points. 
  • Home equity loans: If you used a home equity loan or home equity line of credit (HELOC) to help cover the cost of improvements to your home you can often deduct the interest on the HELOC loan. 

What expenses are not deductible?

There are a number of homeowner expenses that are not deductible, here is a quick list of expenses you are not allowed to deduct:

  • Interest on a mortgage for a third or more home
  • Interest on a reverse mortgage
  • Homeowners insurance
  • Appraisal fees
  • Notary fees
  • Closing costs or down payment money
  • Any extra payments you make to pay down the principal
  • Home equity loan funds that are not used to improve your home

Special considerations related to the mortgage interest deduction

There are a variety of exceptions related to the mortgage deduction. This area can get complicated so it may be a good idea to consult a tax professional if you have any questions regarding specific exceptions. Here are a few of the more common exceptions: 

  • Home office: If you have a home office that you use for work, you cannot deduct the portion of your home that is used as an office. You will have to calculate the square footage of your home and deduct the workspace from that total. 
  • Home sale: If you sold your home last year you can deduct the interest you paid on your mortgage, up to the date of the sale of the house. 
  • Points when refinancing: If you refinanced your home and paid points to lower your interest rate, you cannot deduct the amount paid for those points. 

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