Deducting Mortgage Interest

The IRS allows eligible taxpayers to deduct the interest paid on loans for qualified homes, as well as interest paid on home equity loans (HEL) and home equity lines of credit (HELOC). A qualified home is one that has sleeping, cooking and toilet facilities. This can include your primary residence, a second home, a condominium, a mobile home, a house trailer or even a boat.

At the start of each new year, you’ll receive a mortgage interest statement, known as Form 1098, from your lender. This form lists the amount of mortgage interest you paid during the previous year. If you took out a mortgage to buy, build or improve your home, you can deduct 100% of your mortgage interest as long as your loan is for less than $1 million and the mortgage was taken out as “married couple filing jointly” or by yourself (the limit is $500,000 for married couples filing separately).

An important thing to keep in mind about mortgage interest deductions is that the tax benefit is a mere fraction of what you pay in interest. For example, if you paid $12,000 in mortgage interest for the year and pay an income tax rate of 35%, the amount of your deduction would be $4,200. In other words, only 35% of what you paid in mortgage interest is excluded from taxation. The value of mortgage interest deduction declines every year as you pay more toward the loan principal (the amount of money borrowed from the lender) and less toward interest. Before you take a tax deduction on mortgage interest, you should verify with the IRS or check with your tax advisor to make sure your loan meets IRS requirements.  

An important thing to keep in mind about mortgage interest deductions is that the tax benefit is a mere fraction of what you pay in interest.

You can deduct the interest you pay on:

  • Qualified home loans. To qualify for the tax deduction, you must have taken out a secured loan for the home purchase. This means that you’ve pledged some type of asset, such as the house, as collateral for the loan.

  • Interest paid on HELs or HELOCs. If you spend the loan money from a HEL or HELOC on home improvements, the interest may be deductible in the year you take out the loan, depending on whether you’re subject to the alternative minimum tax. However, if you use the money for something else, like a car purchase, you must spread out the deductions, if eligible, over the length of the equity loan. Generally, home equity debts of $100,000 or less may be fully deductible. 

  • Mortgage discount points. Points are a form of prepaid interest that you may choose to pay at closing to obtain a lower interest rate on your mortgage. You may be able to take this deduction in the year that you purchase the home. If you pay points during a loan refinance , you must spread out the tax deductions over the life of the loan.

  • Private mortgage insurance (PMI). PMI protects the lender should you default on a loan. Homebuyers who contribute less than 20% toward a down payment may be required to pay PMI. Since 2007, homeowners have been allowed to deduct PMI on their taxes. Consult with your accountant/financial advisor to determine if you qualify for a PMI deduction.

Nondeductible Expenses

Many expenses that come with being a homeowner aren’t tax-deductible. These include:

  • payments made toward the loan principal
  • loan down payments 
  • closing costs 
  • title insurance 
  • homeowners insurance 
  • homeowners association dues or condo dues
  • utilities

Itemizing Expenses

A standard tax deduction is a set amount determined by the IRS that you’re allowed to deduct from your taxable income every year. It’s sort of like tax-free income. Standard deduction amounts vary depending on your tax filing status. Depending on your filing status, there are different standard deductible amounts for taxpayers who are single, married filing separately or jointly and heads of households. Use this IRS calculator to figure out your standard deduction amount.

You have the option to not take the standard deduction and instead itemize (individually list) your deductions. Itemizing may allow you to deduct more money than using the standard deduction.
In order to claim mortgage interest or discount point deductions on your taxes (if eligible), you must use IRS Form 1040 to file your taxes and Schedule A to report itemized deductions. On Schedule A, you’ll combine the mortgage interest deduction with other deductions, such as property taxes. This combined itemized total will reduce the amount of your income that is subject to taxation on your federal tax return.

If your total itemized deductions don’t equal the standard deduction amount set by the IRS, then you’ll get more of a tax break from taking the standard deduction and not the itemized ones. This essentially means that you don’t get any tax benefit from paying mortgage interest.

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