Home mortgage interest is tax-deductible, but people often have misconceptions about who benefits from this deduction and how helpful it truly is. It’s important to remember that the tax rules recently changed due to the Tax Cuts and Jobs Act, as well. These changes altered the standard deduction, which in turn impacted the mortgage interest deduction as well. As a result, most taxpayers no longer benefit from deductions relating to mortgage interest and home ownership. Here’s what you need to know about mortgage debt and tax liability.

Is A Mortgage Tax Deductible?

Technically, no — your mortgage debt is not tax-deductible. You can, however, claim a tax deduction for interest payments you make related to the mortgage. In a nutshell, the principal on your mortgage loan is not tax-deductible, but the interest is in most cases. It may or may not behoove you to take the deduction, however, depending on your unique tax situation.

When thinking about and calculating your deduction, make sure you don’t sell yourself short. If you’re buying a second home, the interest that you pay on it is also tax-deductible. Be careful if you rent out your second home, however. If you do, you can only take the tax deduction for the mortgage interest if you live in the house for more than 14 days a year or live there for more than 10 percent of the days that you rent it out, whichever is longer. You don’t have to stay in the house at all, however. So long as you don’t rent it out, simply owning the house is enough to make the mortgage interest eligible for a tax deduction. You can’t claim the deduction on a third or fourth home, though. The IRS limits you to deductions on two mortgages at a time.

You can also take the mortgage interest deduction on a home equity loan or a mortgage you acquired to buy out your former spouse as part of a divorce. Note, however, that in order to qualify for the deduction, you must have a mortgage on a property that meets the IRS definition of a home. This can be a house, houseboat townhouse, condominium, apartment, or other property so long as it has sleeping, cooking, and toileting facilities. If your dream is to retire to a remote yurt in the countryside, you may have to forgo the deduction on that particular property.

What Qualifies As Mortgage Interest?

If you do qualify for the home mortgage interest deduction, make sure you claim everything that you can. Any interest you pay is tax-deductible, but so are quite a few related expenses.

Payments you make for private mortgage insurance (PMI) are also deductible. PMI is a type of insurance your lender will require you to carry if your down payment was less than 20 percent of your mortgagee. PMI protects your lender if you default on the loan.

The IRS does limit your private mortgage insurance deduction, however. To qualify for the deduction, your insurance contract must begin after 2006. You’re also subject to income limits. If you’re married filing jointly, you cannot deduct the cost of PMI if your adjusted gross income exceeds $109,000. If filing single, or married filing separately, you can’t deduct your PMI if your adjusted gross income exceeds $54,500. The IRS reduces your PMI deduction if your adjusted gross income exceeds $100,000 or $50,000 respectively.

Be careful not to confuse PMI with homeowners insurance or title insurance. Homeowners insurance protects you if your home suffers fire or other damage and title insurance ensures that your property title is valid. Insurance premiums you pay for PMI are deductible, but those you pay for title insurance and homeowners insurance are not.

In addition to mortgage interest and PMI payment, you may also deduct property taxes
you paid for your home and the land on which it sits. If you purchased your house during the tax year, you’ll find a breakdown of any property taxes you paid on your closing statement. If you didn’t buy the home this year, you should get a Form 1098 from your mortgage company detailing any taxes you paid. In the event that you paid property taxes that weren’t included in your mortgage payment, you will have to rely on your own records to deduct the taxes you paid.

When deducting mortgage interest, you may also deduct points in some cases. Points are fees you can pay your lender to reduce the amount of your mortgage interest. You can deduct any points you paid as part of your mortgage interest if you meet eight IRS requirements. Those requirements are as follows:

  • The mortgage must be for your primary home, not a second or vacation home.
  • Paying points must be common practice in your area.
  • The points must not be unusually high.
  • The points can’t be used for closing costs.
  • Your down payment must exceed the value of the points.
  • The points must be calculated as a percentage of your loan.
  • The points must appear on your settlement or closing statement.
  • You must use the cash method of accounting for your taxes.

Mortgage Interest Deduction Limits

Mortgage Interest deduction limits

When claiming the home mortgage interest deduction on your tax return, you must recognize that the deduction does have its limits. You can deduct your mortgage interest only on the first $750,000 of your loan. If you bought your house before December 15, 2017, you can deduct the interest up to $1 million. After that, however, you’re limited to the $750,000.

Note that this $750,000 limit applies to married couples. It drops to $375,000 for single filers and those who are married but file separately. There are also several items that taxpayers sometimes erroneously deduct. You cannot deduct moving expenses unless you are active-duty military. The IRS also prohibits the deduction of interest accrued on reverse mortgages, earnest money or down payments you forfeited, and money paid to live in the home before you purchased it.

As always, however, there are a few exceptions to these IRS rules. If you took out your mortgage before October 13, 1987, there is no limit on your deduction. Any and all mortgage interest you pay is fully deductible. You can also sneak in on the $1 million limit if you were in the midst of buying your house before December 15, 2017. If you already had a binding contract with a proposed close date before January 1, 2018, you can deduct the interest up to the $1 million limit so long as you actually closed by April 1, 2018.

Mortgage Interest Deduction vs Standard Deduction

Even if you’re mortgage is fairly young and you’re making hefty interest payments, you may not get to take the mortgage interest deduction. Here’s why. This particular tax deduction is available only to taxpayers who itemize their deductions. In order to take the deduction, you must complete a Form 1040 Schedule and list all of your deductions, from medical expenses to charitable donations.

To make life easier, the IRS gives you the option to take these individual deductions based on your actual expenses or to simply take the standard. If you take the standard, your taxes become easier to calculate but you lose the opportunity to take specific deductions like the one for mortgage interest.

The Tax Cuts and Jobs Act

For better or worse, the Tax Cuts and Jobs Act of 2017 raised the standard deduction, almost doubling it. As a result, far fewer taxpayers now benefit from itemizing their deductions. This also means that far fewer taxpayers benefit from taking the home interest tax deduction — a lot fewer based on the numbers.

The year after the Tax Cuts and Jobs Act, there were 80 million outstanding mortgages in the United States. But only 16.46 million claimed the mortgage interest deduction. The large disparity in these numbers indicates that many, many taxpayers failed to benefit from the interest deduction.

It’s easy to see why if we run some actual numbers. We won’t bore you with every gritty detail, but here is a basic example. Pretend that in the year 2021 you find yourself in the 35 percent tax bracket. You paid $12,000 of mortgage interest for the year. If you’re filing single and you do the math, the standard deduction benefits you by $192.50 more than the mortgage deduction. If you’re married and filing jointly, the standard saves you $4,585 over the mortgage deduction.

Our example illustrates only one aspect of the tax law changes made by the Tax Cuts and Jobs Act. Other changes may ultimately result in a lower overall tax liability for some taxpayers even though the benefit of the mortgage interest, in particular, might be reduced.

The takeaway here isn’t that the new tax law is necessarily good or bad, but that it’s important to understand it or work closely with an accountant who does. Historically, taxpayers have frequently assumed that buying a home would provide a tax break and that it would be a sizeable one. In many cases, neither assumption was ultimately true. This situation is even more likely now than in the past, so make sure you don’t buy a home with unrealistic expectations about how much it will benefit your tax picture.

Who Should Take the Home Mortgage Interest Deduction?

Mortgage Interest

Don’t assume that just because you can take the mortgage deduction you should take the mortgage deduction. This mistake could cost you a lot of tax dollars. The IRS forces you to choose between taking the standard or itemizing your deduction when you file your tax return. But it also allows you to choose whichever option benefits you the most.

To determine this, simply add your tax deductions for the year, including your deduction for any mortgage interest that you paid. If your itemized deductions add up to more than the standard, take the itemized deduction. If not, take the standard. For the 2021 tax year, the standard deductions are $25,100 for married couples filing jointly and $12,550 for single taxpayers and those who are married but filing separately. The standard deduction for head of household filers will be $18,800.

If your itemized deductions are higher, use them and remember to add your mortgage deduction. If your itemized deduction is lower, you will most likely benefit from taking the standard deduction even though it means forgoing any mortgage-related deductions.

Here’s an example borrowed from Rocket Mortgage. Let’s say you’re single. Your mortgage interest is $6,000, your student loan interest is $1,000 and you made $1,2000 in charitable donations. All totaled, your itemized deductions for the year are $8,200. In this case, it makes sense to take your standard deduction, which is a much higher $12,550.

Now let’s change things up. What if your mortgage interest increases to $11,000 and all your other deductions remained the same? In this case, your itemized deductions total $13,200. Now you would benefit from itemizing your deductions and taking the deduction for your mortgage interest because your $13,200 worth of itemized deduction exceeds the standard deduction of $12,550. The higher your deduction, the lower your taxes, so always aim for the highest deduction when you have a choice.

A Tax Pro Can Help

Trying to determine your standard versus itemized deductions can be confusing, and it’s easy to miss deductions that could help you. There are many possible deductions and the rules governing them are varied and sometimes quite complex. Fortunately, you don’t have to try and figure it all out on your own. Whether you have questions about how your mortgage will affect your taxes or about itemizing your deductions in general, the pros at Picnic Tax are ready to help. Give us a call or send an email today and put our expertise to work for you. Whether you already own your home or are thinking about buying, we can paint you a realistic picture of how your mortgage debt and taxes can work together.