What you need to know about the mortgage interest deduction

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The mortgage interest deduction allows homeowners to reduce their taxable income by the amount of interest paid on the loan. (Shutterstock)

Many people think tax time is frustrating, confusing, or downright dreadful. But if you know about some potential deductions, you may be able to increase your tax refund (or at least reduce the amount you’ll owe).

A potentially attractive tax deduction for homeowners is the mortgage interest deduction. This article will help you understand the mortgage interest deduction, who can claim it, and how to include it on your tax return.

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What is the mortgage interest deduction?

The mortgage interest deduction allows homeowners to deduct the interest they paid on their mortgage. The mortgage can relate to your principal residence and to a secondary or secondary residence.

To claim the mortgage interest deduction, you must itemize the deductions. This means that your total itemized deductions – including out-of-pocket medical expenses, state and local taxes, deductible mortgage interest, and charitable contributions – must be greater than the standard deduction available for your filing status.

Because owning a home can significantly increase your itemized deductions thanks to property taxes and mortgage interest, many homeowners view the mortgage interest deduction as a benefit of home ownership.

How does the mortgage interest deduction work?

Your The mortgage interest deduction may be limited depending on the amount of your mortgage and the date you took out your mortgage.

The Tax Cuts and Jobs Act (TCJA) of 2017 capped this deduction for people who took out mortgages after January 1, 2018. If your mortgage started after that date, you can deduct interest paid on up to $750,000. $ of “home acquisition debt,” which is debt used to buy, build, or significantly improve your home. This $750,000 applies whether you are single or married, although married couples who file separate returns will be limited to interest paid on up to $375,000 of home acquisition debt each. This limit still applies if you took out your mortgage before January 1, 2018.

If you took out your mortgage before January 1, 2018, you are allowed to deduct interest paid on up to $1 million of home acquisition debt, plus $100,000 of home equity debt.

The $750,000 limit is set to expire Dec. 31, 2025, unless Congress acts to extend it. The TCJA also eliminated the home equity debt deduction. But that doesn’t mean that all interest paid on a home equity loan or home equity line of credit (HELOC) is no longer deductible.

Home equity loans and HELOCs

The IRS considers any home equity loan or line of credit used to buy, build, or substantially improve the home to be home acquisition debt, so the interest is still deductible.

For example, let’s say you take out a $700,000 mortgage to buy your house and then a $100,000 mortgage to remodel the kitchen. You can deduct all the interest paid on the first mortgage and half the interest on the HELOC. All funds have been used to purchase and improve your home, but you are limited to $750,000.

On the other hand, let’s say you take out a $700,000 mortgage to buy your home, then take out a $20,000 HELOC to refinance high-interest credit card debt. Interest on the first mortgage is deductible, but any HELOC interest is not deductible because it does not count as home acquisition debt.

Also keep in mind that the $750,000 limit applies to all mortgages on your principal residence and your secondary residence combined.

What is considered mortgage interest?

Mortgage interest doesn’t just apply to single-family homes. This also applies to condominiums, cooperatives, mobile homes, motorhomes and houseboats, provided they have facilities for sleeping, cooking and toilets.

And it’s not strictly limited to the amounts you paid for interest. You can also deduct:

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What is not deductible?

The amount you pay each month to your mortgage lender usually includes several items other than interest. If your payment includes any of the following, it is not deductible mortgage interest:

  • Regular principal payments
  • Additional principal repayments designed to prepay your loan
  • Property taxes paid into an escrow account (property taxes are deductible, but not as part of the mortgage interest deduction)
  • Home insurance premiums

How to Claim the Mortgage Interest Tax Deductionnot

If you think it might be beneficial to claim the mortgage interest deduction, here’s how to do it:

  1. Obtain your Form 1098 from your lender. After the end of each year, your lender(s) must send you a Form 1098 showing the total interest, mortgage insurance premiums, and deductible points you paid that year. To complete your tax return, you will need this form.
  2. Decide if you want to claim the standard or itemized deduction. You can only deduct mortgage interest if you itemize the deductions. Add up your total itemized deductions for the year, including medical expenses, taxes, interest, and charitable contributions. If your total is more than the standard deduction available — $12,550 for single filers and $25,100 for joint filers in 2021 — you’ll likely get a detailed breakdown. Otherwise, you better claim the standard deduction. If you’re not sure which option is better for you, most tax software will analyze the numbers and tell you which option is best for you.
  3. Complete Schedule A. Schedule a is the form used to itemize deductions. It has lines for entering mortgage interest and points, mortgage insurance premiums, and other itemized deductions. You can find more information on completing Schedule A in the IRS Instructions for Annex A. You will need to attach it to your Form 1040. You do not need to send a copy of your Form 1098 to the IRS – just keep it with your tax records.

When to use the mortgage interest deduction?

Although almost all homeowners qualify for the mortgage interest deduction, it doesn’t make sense in all situations. Here are some scenarios in which claiming the mortgage interest deduction might make sense to you:

  • You have many other itemized deductions. Itemizing only makes sense if your total itemized deductions are greater than the standard deduction available for your filing status. Since the TCJA has nearly doubled the standard deduction for each filing status, nearly 90% of taxpayers claim the standard deduction. But you might benefit from a breakdown if you have a high mortgage balance, live in a high-tax state, make a lot of charitable donations, or have a lot of medical bills.
  • You file separately from your spouse, and your spouse details. A tricky part of filing a separate tax return from your spouse is that if one spouse is itemizing, both must be itemizing — even though one would benefit more from claiming the standard deduction. If you and your spouse file separate returns and your spouse itemizes, claiming the mortgage interest deduction may increase your deductions on Schedule A.

If you are unsure whether you should benefit from the mortgage interest deduction or have questions about your tax obligations, it is advisable to consult a qualified tax professional for advice.

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