Buying and owning a home can be expensive. Fortunately, mortgage interest rates have fallen to record lows, making financing a home somewhat more affordable, and homeownership itself can be a vehicle for wealth.
There’s also another financial perk for homeowners: You may be able to take advantage of the mortgage interest deduction, which can lower the taxes you pay.
IRS rules regarding the mortgage interest deduction can be complicated and confusing, however. Here’s more about what interest qualifies for the deduction and how you can benefit if you’re eligible.
What is the mortgage interest deduction?
If you have a home loan, the mortgage interest deduction allows you to reduce your taxable income by the amount of interest paid on the loan during the year. The deduction applies only to the interest on your mortgage, not the principal, and in order to claim it, you need to itemize your deductions.
The mortgage interest deduction has been around for more than 100 years, although the rules have changed over time, most recently with the Tax Cuts and Jobs Act of 2017.
Mortgage interest deduction in 2020
If your home was purchased before Dec. 16, 2017, you can deduct the mortgage interest paid on your first $1 million in mortgage debt. For mortgages taken out since that date, you can deduct the interest on the first $750,000. Note that if you were under contract before Dec. 16, 2017, and the mortgage closed prior to April 1, 2018, your mortgage is considered to have been before Dec. 15, 2017.
While almost all homeowners qualify for the mortgage interest tax deduction, you can only claim it if you itemize your deductions on your federal income tax return by filing a Schedule A with Form 1040 or an equivalent form.
Because of this, you’ll have to decide whether it’s better to deduct the mortgage interest by itemizing or taking the standard deduction. The standard deduction is currently $12,400 for single filers and $24,800 for married taxpayers filing jointly.
Let’s say you’re a single homeowner who spent $15,000 in mortgage interest in 2019. It would make sense in this scenario to itemize your deductions, as you’ll reduce your taxable income by a greater amount than you would if you were to take the standard deduction ($12,400).
As with all tax-related matters, you should consider working with a tax expert to help maximize your deductions.
Benefits of the mortgage interest deduction
The key benefit of taking the mortgage interest deduction is that it decreases the total tax you pay.
Case in point: If you pay $10,000 in mortgage interest and are in the 33 percent tax bracket, you’ll lower your tax bill by $3,300 after subtracting the $10,000 deduction from your income.
“Those in higher tax brackets will benefit the most as they will see larger deductions,” notes Kelly Crane, president and chief investment officer of Napa Valley Wealth Management, based in St. Helena, California.
In fact, lower-earning taxpayers get less benefit overall, explains Andrew Latham, a certified personal finance counselor with SuperMoney in Santa Ana, California.
“Taxpayers who make less than $100,000 actually only receive 11 percent of the benefits from this deduction,” Latham says, citing a report by the Tax Foundation. “By contrast, taxpayers who earn $200,000 or more a year get a bigger benefit — 60 percent of the total savings from the mortgage interest deduction.”
Qualifications for the mortgage interest deduction
Most homeowners qualify for the mortgage interest deduction, but there are certain exceptions. You can deduct the interest paid for your primary residence, for example, but if you have a second home you’re renting out, there could be complications.
“Second homes that you don’t live in as a primary residence are eligible, but if you are renting them out, you need to have physically stayed in the property for 10 percent of the rental time over a year,” explains Jess Kennedy, co-founder and chief compliance officer/general counsel at Beeline, a lender in Providence, Rhode Island.
If you have a second home that’s rented out and you don’t meet the 10 percent usage requirement, the home would fall under the rental property category, which has other tax implications.
If you have a second home and aren’t renting it out, however, you can deduct the mortgage interest. You don’t have to use the home during the year, either, to qualify.
Other mortgage-related deductions
In addition to interest paid on a mortgage, you can currently also deduct mortgage insurance premiums (so long as your adjusted gross income is below a certain amount), mortgage points and mortgage late payment fees.
You can also deduct the interest paid on a home equity loan or home equity line of credit (HELOC) or another line of credit secured by your home, but there are rules you must meet and certain payments you can’t deduct. Generally, the financing must have been used to “buy, build, or substantially improve” the property, according to the IRS.
“Imagine you took out a home equity line of credit and borrowed $30,000 to replace your roof and another $20,000 to pay for your child’s college tuition. Here, you will only be able to deduct the interest from the $30,000 you spent on the roof,” Latham says.
There are some expenses that can’t be itemized, Kennedy says, including:
- Homeowners insurance
- Accelerated mortgage payments
- Closing costs/down payment
- Deposit/earnest money
How to claim the mortgage interest deduction
Your lender keeps track of the mortgage interest you paid and will provide this information to you and the IRS via Form 1098, which typically arrives each January or February.
To claim the mortgage interest deduction, you’ll need to report the interest paid, as indicated on Form 1098, on Schedule A (with Form 1040 or 1040-SR), Line 8a. If you use a professional tax preparer, make sure he or she itemizes your deductions and includes the mortgage interest paid on your tax return.
How the mortgage interest deduction could change in the future
Tax experts anticipate that the mortgage interest deduction should remain in place for the foreseeable future, as it’s a popular option for homeowners and can help make homeownership more affordable.
“Many economists and politicians think the deduction should be eliminated and replaced with lower tax rates across the board, but it’s highly doubtful that any major changes will be coming soon — particularly with an election looming,” Kennedy says.
Crane agrees: “Congress is typically prone to promote homeownership and not pass laws that reduce the incentive to purchase and own a home.”