Understanding Mortgage Interest Deductions for Your Taxes
If you own a home, then it’s important to understand your mortgage interest deductions for your taxes. As we approach tax season, it’ll be nice to understand how your mortgage interests can be deducted from your taxes.
Wealthy people understand the power of tax law and leverage it to help preserve their wealth and you should too! Learn how these tax deductions can lower your tax liabilities.
Important things you’ll learn:
- What is a mortgage interest deduction
- Rules for rentals
- What qualifies for a tax deduction
- Rules and limitations
- Mortgage interest deduction and refinancing
What is the home mortgage interest deduction?
Before we talk about mortgage interest deduction, let’s first understand what a tax deduction is. Tax deductions are expenses you incur through the year that the IRS allows you to subtract from your taxable income. This can lower the amount of money you have to pay in taxes.
Homeowners can take advantage of some big deductions that come along with owning a home, such as the mortgage interest you pay.
The mortgage interest deduction was designed to promote homeownership by allowing property owners to take a significant deduction. This itemized deduction allows a homeowner to deduct the interest they pay on a loan against their taxable income. You can deduct interest for:
- Primary mortgages
- Secondary mortgages
- Home equity lines of credit (HELOCs)
- Home equity loans
This can also apply if you pay interest on a condo, mobile home, boat, or RV used as a residence.
For rentals, there is a catch. The loan must be secured by your principal residences, or a main home or second home. Unfortunately, you can’t deduct interest on your third, fourth, or fifth home—or any property you rent out.
For you to claim this deduction, you must use the property for more than 14 days out of the year or more than 10% of the number of days it’s rented. If you don’t meet this criteria, you will not be able to deduct the interest via Schedule A.
However, if you do have rental properties with mortgages, you will be able to deduct the full mortgage interest as supplemental income “loss” on a Schedule E on your taxes.
Through an IRS perspective, a home can be a house, condo, cooperative, mobile home, boat, or recreational vehicle that has sleeping, cooking, and toilet facilities.
Who can take advantage of the mortgage interest deduction?
In most cases, a homeowner should be able to deduct all of their mortgage interest that they paid the previous year if they meet all of the following requirements:
- Date of the mortgage
- Amount of the mortgage
- How the proceeds are used
If you qualify, what next?
When you file taxes, home mortgage interest is reported on Schedule A of your 1040 tax form. Additionally, this single line-item deduction is what can help you exceed the standard deduction limit and allow you to pick up other Schedule A deductions.
In the situation where you own rental properties that have mortgages, you can also deduct that mortgage interest as well. You can do this by deducting your mortgage interest for your rentals on Schedule E, NOT Schedule A.
Before 2017 and the Tax Cuts and Jobs Act, the maximum amount of debt eligible for the deduction was $1 million. This allowed many to deduct interest on home equity debt of up to $100,000 ($50,000 if you’re married and file separately).
By 2018, the law changed and now the maximum amount of mortgage debt is limited to $750,000 if you are married filing jointly ($375,000 if you are married and file separately). Furthermore, the loan must be used for building, purchasing, or improving your residence and it can be a primary mortgage, secondary mortgage, line of credit, or a home equity loan.
Fortunately, if your mortgage started before December 14, 2017, the IRS considers it grandfathered debt. Meaning, you will receive the same tax treatment as under the old rules, except on other homes bought after.
It is going to be important to communicate with your accountant now to make sure you meet the IRS rule that will allow you to take this deduction. It will be important to forecast how much tax advantages you’ll be able to use.
You can deduct mortgage interest after a refinance, but it can be a little tricky. TurboTax says it best here:
Pay attention to the last statement about refinancing. Essentially, you may be able to deduct the interest of up to $100,000 of the debt as well as 1/30th of the points each year, assuming it’s a 30-year mortgage.
When you sell or refinance again, you can then deduct all of the discount points not yet deducted—unless you refi with the same lender. In this case, you would add the points on the current loan to the old loan and deduct the points on a prorated basis over the life of the new loan.
This isn’t easy to grasp for everyone. So if it isn’t making complete sense, defer to a tax professional.
What documents do you need to take the mortgage interest tax deduction?
These are the documents you need to file your deduction:
- Copies of all Form 1098
- Copies of all HUD closing statements from a purchase or refinance that show the points you paid
- Information about the person who sold you the property if you purchased your home directly or used seller financing. This includes their name, address, and social security number
- Your federal tax returns
If you plan on deducting mortgage points over the course of 30 years, keep these documents on hand for the entire time you have the property.