Buying a home has never been more expensive, but if you can find one that you can afford, there’s good news after you move in: You may be able to take advantage of the mortgage interest deduction. to reduce your tax bill.
However, the IRS rules regarding mortgage interest deduction can be very complicated. As you contemplate tax season, here’s a guide to help you understand what interest is eligible for the deduction and how you can benefit from it if you qualify.
What is the mortgage interest deduction?
If you have a home loan, mortgage interest deduction can allow you to reduce your taxable income by the amount of interest paid on the loan during the year, as well as other expenses such as mortgage insurance premiums. and points.
The deduction only applies to the interest on your mortgage, not the principal, and to claim it you must itemize your deductions. You can use the mortgage interest deduction calculator on Bankrate.com for an estimate of the kind of savings you can expect when filing your taxes.
Mortgage interest deduction has been around for over 100 years, but has evolved over time. Different administrations have changed the rules for this benefit, and former President Donald Trump’s tax reform has affected who can benefit from it.
Mortgage interest deduction limit
If your home was purchased before December 16, 2017, you can deduct mortgage interest paid on your first million dollars in mortgage debt ($ 500,000 if you’re married and filing separately).
For mortgages taken out since that date, you can only deduct interest on the first $ 750,000 ($ 375,000 if you’re married and filing separately). Note that if you were under contract before December 15, 2017 and the mortgage loan was closed before April 1, 2018, your mortgage loan is deemed to have been contracted before December 16, 2017.
Take the mortgage interest deduction for your 2021 tax return
While almost all homeowners are entitled to the mortgage interest tax deduction, you can only claim it if you itemize your deductions on your federal income tax return by completing a Schedule A with Form 1040 or equivalent.
For this reason, you will need to decide whether it is better to deduct mortgage interest by itemizing or taking the standard deduction. The standard deduction for the 2021 tax year is $ 12,550 for single tax filers and $ 25,100 for married taxpayers filing jointly. For the 2022 tax year, these amounts are $ 12,950 for single tax filers and $ 25,900 for married spouses.
Let’s say you are a single homeowner who spent $ 18,000 on mortgage interest in 2021. It would make sense in this scenario to itemize your deductions because you are reducing your taxable income by a larger amount than if you had to take the standard deduction. .
If you’re not sure what the best course of action is, consult a tax professional to help you understand the best decision for your financial situation.
What constitutes mortgage interest?
The general IRS definition of “mortgage interest” is the interest that accrues on any loan secured by your primary residence or second home. Other costs and charges may also be included in the mortgage interest deduction. Here is an overview:
– Any interest in your home: The property must include facilities for sleeping, cooking and eating and may be a house, condo, co-op, mobile home, boat or recreational vehicle.
– Interest on a second home that you don’t rent: If you are renting the property during a certain time of the year, you will need to adhere to certain guidelines (in particular, use it for your own use longer than 14 days or more than 10% of the rental time, whichever is longer) to deduct interest. Be sure to inquire about other tax deductions for rental property.
– Most mortgage loan insurance premiums: For the 2020 tax year, if your Adjusted Gross Income (AGI) is greater than $ 109,000 as a married couple or $ 54,500 if you are filing individually, you cannot deduct mortgage insurance charges.
– Late payment fees: If you are late on a payment, you can probably deduct the additional fees charged to you.
– Penalties for early repayment: If you are charged a penalty fee for prepaying your mortgage, you can deduct this amount.
– Points: If you paid points to reduce your mortgage interest rate, you can deduct a portion that applies to the individual reporting year.
– Home equity loans and home equity lines of credit used to improve your home: If you took out a Home Equity Line of Credit (HELOC) or Home Equity Loan to pay for a home improvement project, you can deduct interest on the amount you used to modernize your property.
What is not deductible?
– Interest on a mortgage for a third or fourth house
– Any interest on a reverse mortgage
– Home insurance
– Expertise fees
– Notary fees
– Closing costs or down payment
– Additional payments made on the principal
– Home equity loan funds or HELOC funds used for purposes unrelated to your property (for example, if you borrowed against your home to pay for a wedding, these funds are not deductible)
Special considerations for deducting mortgage interest
When you review the IRS’s guide to mortgage interest deduction, you will notice a lot of language that details exceptions in certain situations. Below is a partial list of these special considerations. If you have a unique circumstance, check the most recent IRS publication 936 on irs.gov or seek advice from a tax professional.
– Home office complications: If you are using part of your property for a home office, you will need to calculate the specific square footage used for living versus work. The âinhabitantâ space is the only part that qualifies for a mortgage interest deduction.
– House under construction: If you are building a house, you have a 24 month period that qualifies under the mortgage interest deduction guidelines.
– Home sales: If you sold your home last year, you can still deduct the interest accrued on the loan up to the date of sale, but not included.
– Pay points when refinancing: If you refinanced your mortgage in 2021 and paid points to reduce the rate, you probably won’t be able to fully deduct the cost of those points. Instead, you may be able to deduct some of those points over the life of the new loan.
How to claim mortgage interest deduction
Step 1: Watch for communications from your lender or manager in early 2022. You don’t have to track the amount of interest you pay; your lender or agent will do this and send you Form 1098. This should arrive in late January or early February, and should also include mortgage insurance premiums and any prepaid interest.
2nd step: Do the math. You will need to determine whether the breakdown of your deductions (your mortgage interest charges and any other eligible deductions) will give you more than the standard deduction.
Step 3: Give your Form 1098 to your tax professional or complete Schedule A of Form 1040 yourself. All reported mortgage interest will be entered on line 8a, any unreported interest will appear on line 8b, and mortgage loan insurance premiums will appear. on line 8d.
Benefits of deducting mortgage interest
The main advantage of deducting mortgage interest is that it can reduce the total taxes you pay. Let’s say you paid $ 10,000 in mortgage interest and you are in the 32% tax bracket. You reduce your tax bill by $ 3,200 after subtracting the $ 10,000 deduction from your income.
“Those in the higher tax brackets will benefit the most because they will see larger deductions,” notes Kelly Crane, president and chief investment officer of St. Helena-based Napa Valley Wealth Management, in California.
In fact, lower income taxpayers get fewer benefits overall, says Andrew Latham, certified personal finance advisor and editor at SuperMoney in Santa Ana, California.
âTaxpayers who earn less than $ 100,000 actually only receive 11% of the benefits of this deduction,â Latham said, citing a 2019 Tax Foundation report. “In contrast, taxpayers who earn $ 200,000 or more per year get a larger benefit – 60% of the total savings from deducting mortgage interest.”