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Mortgage interest deduction explained

Mediafeed logo Mediafeed 9/25/2021 Sheryl Nance-Nash
a laptop computer sitting on top of a car: mortgage © mortgage

Homeownership has long been a part of the American dream, and it opens the door to benefits like the mortgage interest deduction for those who itemize deductions on their taxes. Itemizing typically makes sense only if itemized deductions on a primary and second home total more than the standard deduction, which nearly doubled in 2018.

Here’s what you need to know about the mortgage interest deduction.

Related: A homeowner's guide to HELOC loans

What is the mortgage interest deduction?

The deduction allows itemizers to count interest they pay on a loan related to building, purchasing, or improving a primary home against taxable income, lowering the amount of taxes owed. The tax deduction also applies if you pay interest on a condominium, cooperative, mobile home, boat, or recreational vehicle used as a residence. The deduction can also be taken on loans for second homes, as long as it stays within the limits.

States with an income tax may also allow homeowners to claim the mortgage interest deduction on their state tax returns, whether or not they itemize on their federal returns.

What are the rules and limits?

The passage of the Tax Cuts and Jobs Act of 2017 was a game-changer for the mortgage interest deduction. Starting in 2018 and set to last through 2025, the law greatly increased the standard deduction and eliminated or restricted many itemized deductions. For the 2020 tax year, the standard deduction is $24,800 for married couples filing jointly and $12,400 for single people and married people filing separately.

If you itemize deductions, you’re good to go and can deduct the interest. There’s further good news, as you may also be able to deduct interest on a home equity loan or line of credit, as long as it was used to buy, build or substantially improve your home. The loan must be secured by the taxpayer’s main home or second home and meet other requirements. For tax purposes, a second home not used for income is treated much like one’s primary home. It’s a home you live in some of the time.

The IRS considers a second home that’s rented some of the time one that you use for more than 14 days, or more than 10% of the number of days you rent it out (whichever number of days is larger). If you use the home you rent out for fewer than the required number of days, it is considered a rental property — one that you never live in and not eligible for the mortgage interest deduction.

Generally, your interest-only mortgage is 100% deductible, as long as the total debt meets the limits. According to the Internal Revenue Service, you can deduct home mortgage interest on the first $750,000 ($375,000 if married filing separately) of debt. Higher limitations ($1 million, or $500,000 if married filing separately) apply if you are deducting mortgage interest from debt incurred before Dec. 16, 2017.

You can’t deduct home mortgage interest unless the following conditions are met.

  • You must file Form 1040 or 1040-SR and itemize deductions on Schedule A (Form 1040)
  • The mortgage must be a secured debt on a qualified home in which you have an ownership interest

Simply put, your mortgage is a secured debt if you put your home up as collateral to protect the interests of the lender. If you can’t pay the debt, your home can then serve as payment to the lender to satisfy the debt. A qualified home is your main home or second home. The home could be a house, condo, co-op, mobile home, house trailer or a houseboat. It must have sleeping, cooking and toilet facilities.

Know that the interest you pay on a mortgage on a home other than your main or second home may be deductible if the loan proceeds were used for business, investment or other deductible purposes. Otherwise, it is considered personal interest and is not deductible.

How much can I deduct?

No doubt you want the answer to that question. In most cases, you can deduct all of your home mortgage interest. How much you can deduct depends on the date of the mortgage, the amount of the mortgage, and how you use the mortgage proceeds.

The IRS says that if all of your mortgages fit into one or more of the following three categories at all times during the year, you can deduct all of the interest on those mortgages. (If any one mortgage fits into more than one category, add the debt that fits in each category to your other debt in the same category.)

  1. Mortgages you took out on or before Oct. 13, 1987 (called grandfathered debt). Mortgages you (or your spouse if married filing jointly) took out after Oct. 13, 1987, and prior to Dec. 16, 2017, to buy, build, or substantially improve your home, but only if throughout 2020 these mortgages plus any grandfathered debt totaled $1 million or less ($500,000 or less if married filing separately).
  2. (There is an exception. If you entered into a written contract before Dec. 15, 2017, to close on the purchase of a principal residence before Jan. 1, 2018, and you purchased the residence before April 1, 2018, you are considered to have incurred the home acquisition debt prior to Dec. 16, 2017.)
  3. Mortgages you (or your spouse if married filing jointly) took out after Dec. 15, 2017, to buy, build, or substantially improve your home, but only if throughout 2020 these mortgages plus any grandfathered debt totaled $750,000 or less ($375,000 or less if married filing separately).
The dollar limits for the second and third categories apply to the combined mortgages on your main home and second home.

What are special circumstances?

Life sometimes isn’t black or white, but gray. Just like you need to understand your home loan options, you need to know the special situations where the IRS says you might or might not qualify for the mortgage interest deduction.

You can deduct these items as home mortgage interest:

  • A late payment charge if it wasn’t for a specific service performed in connection with your mortgage loan
  • A mortgage prepayment penalty, provided the penalty wasn’t for a specific service performed or cost incurred in connection with your mortgage loan

You cannot deduct the interest paid for you if you qualified for mortgage assistance payments for lower-income families under Section 235 of the National Housing Act.

Is everything deductible?

The government is only so generous. There are a lot of costs associated with homeownership. Many of them are not tax-deductible under the mortgage interest deduction, like homeowners insurance premiums. One caveat: You might be able to write off a portion of insurance, as well as utilities, repairs, and maintenance if you have a home office and deduct those expenses on Schedule C.

Also not on the list for inclusion in the mortgage interest deduction are title searches, moving expenses and reverse mortgage interest. Because interest on a reverse mortgage is due when the property sells, it isn’t tax-deductible.

How to claim the mortgage interest deduction

An itemizer will file Schedule A, which is part of the standard IRS 1040 tax form. Your mortgage lender should send you an IRS 1098 tax form, which reports the amount of interest you paid during the tax year. Your loan servicer should also provide this tax form online.

Using your 1098 tax form, find the amount of interest paid and enter this on Line 8 of Schedule A on your tax return. It’s not a heavy lift but gets a tad more complicated if you earn income from your property. If you own a vacation home that you rent out much of the time, you’ll need to use Schedule E. Furthermore, if you’re self-employed and write off business expenses, you’ll need to enter interest payments on Schedule C.

The takeaway

You can take the mortgage interest deduction if you itemize deductions on your taxes. Keep in mind that it’s typically only worth taking if the write-offs exceed the standard deduction. The mortgage interest deduction, though, can be a bonus of sorts, especially if you’re a homeowner with a second home. As with all matters that affect your taxes, you’ll want to consult with your financial advisor about claiming the deduction.

Learn more:

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