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If you’ve been a homeowner for, like, two seconds, you know how frustrating it can be paying for all sorts of fees.
You can potentially knock off some hefty sum from your taxable income through mortgage interest deductions if you own a home with an active mortgage.
Mortgage interest deductions are one of the many tax deductions provided by the IRS for both first-time and seasoned homeowners. To that end, we’ve created a detailed guide on mortgage interest deductions below.
Keep scrolling to learn what it is, how it works, what’s covered under the deduction, and who gets it.
After reading, you should have a much better idea of whether mortgage interest deduction is right for you in 2022.
What Is Mortgage Interest Deduction?
Mortgage interest deduction was designed to promote homeownership by allowing homeowners to deduct the amount they have paid in mortgage interest during the tax year from their taxable income.
What this means is that if you currently have mortgage debt on your current home, you can deduct a specific portion of your mortgage interest each year and pay fewer income taxes.
Thanks to this tax break, as a homeowner, you can deduct interest for:
You can also enjoy mortgage interest deductions if you pay interest on a condo, co-op, mobile home, and even an RV used as your primary residence.
And thanks to the introduction of the Tax Cuts and Jobs Actin 2017, homeowners who bought their primary residence or second home after Dec. 15, 2017, qualify for this deduction for the first $750,000 of mortgage debt.
However, if you bought the property before that date, you can deduct interest on up to $1 million of mortgage interest debt.
How Does Mortgage Interest Deduction Work?
As the name implies, mortgage interest deduction allows you to deduct ONLY the interest and not the principal from your taxable income.
Here is how it works:
Let’s say your monthly mortgage payment is $1,680. That is $580 for your loan principal and $1100 for your mortgage interest. The $1,100 is the part of your mortgage payments you can deduct from your taxable income.
So, at the end of the year, your annual interest payment is more likely to be around $12,580 and $14,780. With your yearly total mortgage interest around $12,580 and $14,780, it exceeds the standard deduction of $12,400 even without including the other itemized deductions. So, it would be best if you itemize your mortgage interest deductions in this scenario.
One crucial fact about tax deductions is that you cannot deduct mortgage interest while taking the standard deduction. To be able to take the mortgage interest deductions, you’ll need to itemize. Itemizing is an excellent option if your accumulative itemized deductions are higher than the allowable standard deduction, between $12,400 and $24,800 for the 2020 tax year, depending on your filing status.
More importantly, the saving you get from itemizing your deductions will highly depend on the amount of mortgage interest you pay, your filing status (whether single or as a couple), and how much your itemized deductions add up to.
If you’re unsure about the amount of interest you have paid on your mortgage, don’t worry. Your mortgage servicer is responsible for keeping track of how much interest and mortgage insurance premiums you pay each year.
What Loans Qualify for Mortgage Interest Deduction?
While this tax break is available to all homeowners, not all loans qualify for mortgage interest deductions.
Generally, home loans geared at helping taxpayers buy, build, or improve their homes can qualify for mortgage interest deductions.
So, traditional mortgage, home equity loans, line of credit, and even second mortgage will be eligible for a mortgage interest deduction. You should speak to your lender and an experienced CPA for proper assistance in this type of situation.
Mortgage Interest Deduction Limit
The introduction of the Tax Cuts and Jobs Act (TCJA) in 2017 lowered the mortgage interest deduction limit.
Before the introduction of the TCJA, the mortgage interest deduction limit was $1 million. But now, homeowners can only deduct mortgage interest on mortgage debt up to $750,000.
This means that couples filing jointly may only deduct interest on up to $750,000 of qualified home loans, down from $1 million in 2017. For married taxpayers filing separate returns, the cap is $375,000; it was previously $500,000.
However, if you took out a mortgage, home equity loan, or even a HELOC on or before December 15, 2017, you can still deduct up to $1 million in mortgage debt.
However, according to the Internal Revenue Service (IRS), there are a few exceptions where a homeowner can deduct all of their mortgage interest:
- Mortgages you took out on or before October 13, 1987 (called grandfathered debt). If your mortgage falls under this category, all the mortgage interest you paid in a tax year is fully deductible.
- Mortgages you (or your spouse if married filing a joint return) took out after October 13, 1987, and before December 16, 2017, to buy, build, or substantially improve your home (called home acquisition debt), but only if throughout 2020 these mortgages plus any grandfathered debt totaled $1 million or less ($500,000 or less if married filing separately).
- Mortgages you (or your spouse if married filing a joint return) took out after December 15, 2017, to buy, build, or substantially improve your home (called home acquisition debt), 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 limit on the second and third categories applies to the combined mortgage debts on both your primary home and second home.
Please seek professional assistance from your mortgage lender to determine if your home falls under one or all the above exception categories.
What Qualifies as Mortgage Interest?
If you’re a new homeowner, you may be wondering what aspect of your home loan qualifies for mortgage interest deductions.
While it is common for interest paid on home loans to be deductible, you can also deduct other parts of your mortgage payments like late payment fees, discount points, and mortgage insurance premiums.
- Primary Residence Mortgage Interest. If your home serves as the collateral for the mortgage, then you can deduct the interest paid on the home mortgage.
- Second-home residence mortgage interest. While interest deductions are more peculiar with mortgages secured by primary homes, it is still possible for you to deduct the interest if your mortgage is secured by a second home you are renting out.
- Late mortgage payments and fees. You can deduct as home mortgage interest a late payment charge if it wasn’t for a specific service performed in connection with your mortgage loan.
- Mortgage prepayment penalty. If you pay off your home mortgage early, you may have to pay a fine. You can deduct that penalty as home mortgage interest, provided the penalty isn’t for a specific service performed or cost incurred in connection with your mortgage loan.
- Discount Points. According to the IRS, the term “points” is used to describe certain charges paid or treated as paid by a borrower to obtain a home mortgage. You can deduct points or mortgage origination fees you pay at closing for your primary home in the year you pay them. However, you can’t deduct the total amount of points in the year you paid them but ratably over the life of the mortgage. For exceptions to this rule, see Deduction Allowed in Year Paid.
- Sale of home. If you sell your home, you can deduct your home mortgage interest (subject to any limits that apply) paid up to, but not including, the date of the sale. So, if you sold your home in March, you can deduct the interest you paid on the home loan from January through February or March, depending on when you made the last mortgage interest payment.
- Ministers’ and military housing allowance. If you’re a minister or a member of the uniformed services and receive a housing allowance that isn’t taxable, you can still deduct your home mortgage interest. Read our guide on VA Home Loans.
- Interest paid on a home equity loan. A home equity loan is a type of loan that allows you to borrow from the built-up equity in your home. While you can deduct interest paid on a home equity loan, you must meet rules 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.
- Mortgage insurance premiums. You can deduct amounts you paid during 2020 for qualified mortgage insurance as home mortgage interest. However, the insurance must be in connection with your home acquisition debt, and the insurance contract must have been issued after 2006.
More importantly, if your adjusted gross income on Form 1040 is more than $100,000 ($50,000 if your filing status is married filing separately), the amount of your mortgage insurance premiums that are otherwise deductible is reduced and may be eliminated.
And if your adjusted gross income is more than $109,000 ($54,500 if married filing separately), you cannot deduct your mortgage insurance premiums.
Are There Any Mortgage Interest Deduction Circumstances?
While the IRS is clear on mortgage interests that are deductible and non-deductible, there are certain special situations where claiming mortgage interest may be difficult or require more paperwork. These special circumstances include:
- If you have a second home that you rent out for part of the year, you must use it for more than 14 days or more than 10 percent of the number of days you rented it out at fair market value (whichever number of days is larger) for the home to be considered a second home for tax purposes. If you use the home, you rent out for fewer than the required number of days, your home is regarded as a rental property, not a second home.
- You may treat a different home as your second home each tax year, provided each home meets the qualifications noted above.
- If you are a co-op apartment owner, you can deduct your share of the interest you pay on the building’s total mortgage.
- If you live in a house before your purchase becomes final, any payments you make for that period are considered rent. You cannot deduct those payments as interest, even if the settlement papers label them as interest.
- If you used the proceeds of a home loan for business purposes, enter that interest on Schedule C if you are a sole proprietor, and on Schedule E if used to purchase a rental property. The interest is attributed to the activity for which the loan proceeds were used.
- If you own rental property and borrow against it to buy a home, the interest does not qualify as mortgage interest because the house itself does not secure the loan. Interest paid on that loan can’t be deducted as a rental expense either because the funds were not used for the rental property. The interest expense is considered personal interest, which is no longer deductible.
- Suppose you used the proceeds of a home mortgage to purchase or “carry” securities that produce tax-exempt income or to purchase single-premium (lump-sum) life insurance or annuity contracts. In that case, you cannot deduct the mortgage interest.
- If your house was destroyed, it might still qualify for mortgage interest deduction, but you must rebuild the home and move back in or sell the land within a reasonable period.
You can check out Pub. 936 from the IRS regarding other special circumstances.
What Is Not Deductible?
When buying a home, you are bound to incur several other expenses. While most homeowners believe that it is possible to deduct these additional expenses, but they aren’t. Here’s a list of some of the typical costs and situations that are not deductible.
- Homeowners insurance
- Title insurance
- Other closing costs
- Earnest money deposits
- Down payments
- If you did a cash-out refinance, you can’t deduct mortgage interest if you failed to use the received for home building, buying, or renovation purposes.
- Interest accrued on a reverse mortgage. Because reverse mortgages are considered loan advances and not income, the amount you receive isn’t taxable. Generally, any interest accrued on a reverse mortgage is considered interest on home equity debt and isn’t deductible.
- Rental payments. If you live in a house before the finalization of the purchase, any payments you make for that period are rent and not interest.
- You can’t deduct moving expenses except if you’re an active-duty military officer.
- You also can’t deduct the interest on any portion of your mortgage debt that exceeds $750,000 ($375,000 for single taxpayers or married taxpayers who file separately) if you took out your mortgage in 2018 or later.
- You can’t deduct mortgage interest on more than one second home.
More importantly, mortgage interest can only be deductible if the home you financed with the mortgage debt is used as the collateral.
How to Claim Mortgage Interest Deduction (Step-by-Step)
Homeowners that meet the IRS stipulated requirements can claim their accumulated mortgage interest tax deductions. You can either decide to work with a tax professional to file your taxes or file them on your own.
If you’ve decided to claim your mortgage interest deductions, then here’s what you need to do to claim your mortgage interest tax deductions.
#1. Get a Copy of Form 1098
Before claiming mortgage interest tax deductions, you will need to determine how much interest you have paid on your mortgage.
To find out how much mortgage interest and points you have paid during the tax year, you will need to check your mortgage interest statement or IRS Form 1098. Typically, your online mortgage lender will send you a copy of the form and another copy to the IRS.
It is common for you to receive it in January or February of each year. Remember that you’ll only get a Form 1098 if you pay more than $600 in mortgage interest annually.
#2. Choose Between Standard Deduction or Itemized Deductions
Before deciding to claim your mortgage interest tax deduction, you’ll need to choose between standard deductions and itemized deductions.
The TCJA lowered the maximum mortgage interest deduction limit and increased the standard deduction limits.
If you decide to stick with the standard deduction, you will not need to provide the IRS with more paperwork or provide proof of all your deductions. This is because the standard deduction is a flat fee across taxpayers.
Due to the recent changes, the standard deduction limit for the 2020 tax year is pegged at:
- $12,400 for single filing status
- $24,800 for married, filing jointly
- $12,400 for married, filing separately
- $18,650 for heads of households
One of the major differences between the standard deduction and itemized deductions is that standard deduction doesn’t require you to pick from your various deductions, while itemized deduction does. If you opt for itemized deductions, then you’ll need to select several other deductions.
These deductions may include mortgage interest, student loan interest, charitable contributions, medical expenses, and more.
To itemize your selected deductions, you’ll need to fill out separate forms for each of the selected deductions. Most of the time, your tax professional will request records, receipts, and paperwork to support the deductions.
Please note that choosing either standard or itemized deductions will reduce your taxable income.
When choosing a type of mortgage interest deduction, you should consider how much money a specific deduction could save you compared to the other. So, if a standard deduction will save you more money, then take the standard deduction. Or vice versa.
For example, John itemizes the following deductions as a single individual: mortgage interest ($7,000), auto loan interest ($800), and charitable donations ($1,500).
These deductions add up to $9,300. In this scenario, it would be better for John to take the standard deduction of $12,400 instead because he would get $3,100 more deducted from his taxable income.
In another case, let’s say John’s mortgage interest is $12,000 and the other deductions stay the same. John’s itemized deductions would total $14,300.
In this situation, it would be better for John to take the itemized deduction because it reduces his taxable income by $1,900 more than the standard deduction would.
If you decide to opt for the itemized deduction method over the standard deduction, you may have to spend more money itemizing your taxes since it requires extra paperwork. Before choosing any deduction method, you should consider discussing your options with a mortgage and accounting expert.
#3. Make Sure You Have the Proper Tax Form
Since mortgage interest is an itemizable item, you will need to file the right tax form to itemize your deductions to claim mortgage interest deductions.
In filing your tax for mortgage interest deductions, you’ll have to choose between using Schedule A (Form 1040) for itemized deductions or the standard 1040 form. These forms allow you to list other deductions you may have chosen in addition to your mortgage interest.
You can find the mortgage interest deduction part on line 8 of your tax form. You’ll copy the information on your form 1098 (mortgage interest) in that section.
When filing your tax forms, there are a lot of twists and turns. That’s because the way interest is deducted from your taxable income will depend on how you used the loan money and not the loan itself.
So, if you’re deducting the interest you paid on rental properties, you must use Schedule E of form 1040 to file it. If you use part of your house as a home office or use money from your mortgage for business purposes, you may need to fill out Schedule C of the Form 1040 to report it.
#4. Check for Special Deductions
Suppose over the tax year, you received help from a State Housing Finance Agency (State HFA) Hardest Hit Fund program or an Emergency Homeowners’ Loan Program administered by the Department of Housing and Urban Development (HUD).
In that case, you may be able to deduct all the payments you made during the year to your mortgage servicer, the State HFA, or HUD on the home mortgage. You should discuss your situation with a tax advisor to see if you qualify for special deductions.
Is Mortgage Interest 100% Deductible?
Yes, taxpayers can deduct up to 100 percent of their mortgage interest from their gross income, along with the other deductions for which they are eligible.
However, there may be certain situations where mortgage interest may not be fully deductible. For example, taxpayers cannot deduct the total cost of prepaid points in the year they paid them.
At What Income Level Do You Lose Mortgage Interest Deduction?
While the introduction of mortgage interest deduction has made homeownership a bliss for most homeowners, the maximum mortgage tax deduction you can receive still depends on your income.
With the latest changes by the Tax Cuts and Jobs Acts, there is an income threshold where every $100 over once breached minimizes your mortgage interest deduction. In 2021, that threshold is pegged at roughly $200,000 per individual and $400,000 per couple for 2021.
Please reach out to a professional tax advisor for more information about your maximum mortgage tax deduction in relation to your income level.
Bottom Line: Mortgage Interest Deduction
The mortgage interest deduction allows homeowners, who itemize taxes, to claim a tax deduction for interest paid on their mortgage.
Under the Tax Cuts and Jobs Act of 2017, the limits decreased from $1 million to $750,000, which means that taxpayers can now claim mortgage interest deduction on the first $750,000 of the mortgage, instead of the first $1 million.
We encourage all our readers to consult a financial advisor or tax professional for further questions about mortgage interest deductions.