One of the key perks of home ownership is the home mortgage interest tax deduction. This benefit holds the potential to reduce your taxable income. However, it doesn’t apply to everyone, nor does it always deliver sizable savings. With those thoughts in mind, here are some things you should know about this deduction.
What is the Home Mortgage Interest Deduction?
Essentially, the interest paid on a home loan during a given tax year is tax deductible. The idea is to encourage home ownership by granting buyers “interest-free” loans. However, it’s important to note that the deduction only applies up to a certain amount — for specific types of properties — and it may not be worthwhile for everyone.
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Qualifying Loans
These are the deductions you can take:
● Interest on loans taken for the purpose of purchasing a primary residence or a second home
● Interest payments on refinanced mortgages
● Interest on home improvement loans for both primary and secondary residences (unless the funds were used to make repairs)
● Home equity loan (as long as the funds were used specifically for buying, building, or renovating a home)
According to IRS Publication 936, as of January 2023, the maximum mortgage interest deduction for individuals is $750k annually or $375k for married couples filing separately. However, home loans written prior to 12/16/2017 may be eligible for deductions up to $1M for individuals and $500k for couples filing separately. Deductions for loans written before 10/14/1987 are both unlimited and unrestricted as to purpose.
It’s important to note that mortgage interest on investment property is not deductible — although many of the expenses associated with owning investment property are.
Qualifying Expenses
In addition to mortgage interest, the deduction may be applied to:
● Mortgage points or pre-paid interest payments included in closing costs
● Mortgage insurance premiums, late payment fees, and prepayment penalties
○ Can be deducted up to the specified limits
○ Interest associated with the acceptance of Hardest Hit Fund and Emergency Homeowners Loan Program benefits
The Deduction Isn’t Dollar for Dollar
As opposed to being a dollar-for-dollar refund like a tax credit, the mortgage interest deduction could lower your tax bill by reducing your taxable income. Those interested in claiming it, or determining whether claiming it is worthwhile, should consult a tax professional and review IRS Form 1040 Schedule A.
Should You Take the Deduction?
This question might seem a bit far-fetched. After all, if the government is willing to foot the bill for your mortgage interest, allowing it to do so seems like a no-brainer — right? However, the Tax Cuts and Jobs Act of 2017 brought with it a significant bump in the standard deduction amounts taxpayers could claim. According to the IRS, those figures for tax year 2022 are $12,950 for individuals, $25,900 for married couples and $19,400 for unmarried heads of households.
This means that some people might be better off taking the standard deduction, rather than itemizing their deductions. In cases in which the amount of mortgage interest paid is more than the standard deduction, you could benefit from claiming it — along with any other deductible expenses you may have had during the previous year. Otherwise, you’ll likely be better off with the standard deduction.
Claiming the Deduction
Mortgage lenders issue Form 1098 detailing the amount of interest borrowers paid over the course of the preceding year. Generally, you will only get this form if you paid more than $600 in mortgage interest. Upon receiving the form, comparing the deductible mortgage interest to the standard deduction for which you qualify should inform your decision, as outlined above. Should you decide to claim it, you’ll need to submit a 1040 Schedule A form along with your tax return documents.
Homeownership will likely be one of the largest purchases you ever make. By taking the right deductions for your financial situation, you can save the most on this important investment.
