How Much Mortgage Interest Is Deductible?
Acquiring a mortgage is one of the most impactful financial decisions of your life. As with anything else that involves so much money, taxes add to the already overwhelming list of things to consider when navigating the transaction. One surprisingly pleasant reprieve comes in the form of a mortgage interest tax deduction that gives you a solid chance to get some of that hard-earned cash back into your pocket.
Homeowners with a mortgage can take advantage of this tax credit as well as several other breaks given to real estate holders. Of course, you will need to learn the ins and outs of the program to take full advantage of the savings opportunities. The following guide will walk you through everything you need to lighten the tax load this season.
What Is a Mortgage Interest Tax Deduction?
The mortgage interest deduction is an incentive enjoyed by homeowners who are still paying down their loans. As an itemized deduction, it allows you to eliminate some of the taxes you owe each year. The money in question is removed from your taxable income pool, meaning no outside sources can touch it at the end of the year. Savvy homeowners can even apply this deductible to a second property, provided they stay within the boundaries proposed by the IRS.
How the Mortgage Interest Tax Deduction Is Applied
The deduction subtracts the amount of money you pay on your mortgage payments each year from your overall taxable income. You will need to keep records and receipts of each of your payments in order to apply them to your tax bill. Single people and married couples can save up to $750,000 each year depending on how much mortgage interest is paid. Married couples filing jointly can receive credit for up to $375,000 each.
Exceptions to the Mortgage Interest Tax Deduction
Depending on when you first signed your mortgage contract, there are a few additional stipulations to take note of. Before the Tax Cuts and Jobs Act, the deduction limit was an even $1 million. If you acquired a mortgage before October 13, 1987, all the interest you pay is still fully deductible with no limit.
Mortgages acquired between October 13, 1987, and December 16, 2017, have a $1 million limit placed on them. If your mortgage was obtained after December 2017, then you will have to abide by the $750,000 limit.
Which Loan Types Are Compatible With Mortgage Interest Deductions?
Despite the name of this tax credit, there is a respectable amount of flexibility in the number of loan types that qualify for the benefit. Your first mortgage, second mortgage, home equity lines of credit, and building improvement loans all qualify for the incentive. Certain refinancing strategies also allow you to start using this credit, so be sure to analyze all your options when it comes time to renegotiate your bill. Buying, improving, or building a home will give you the opportunity to knock some extra charges off your taxes each year.
How to Apply the Tax Credit to Your Return
Like any tax activity, the main focus is on filling out various forms with accurate information. Here is a simple breakdown of what to do when taking advantage of a mortgage deduction.
1. Pick a Standard or Itemized Deduction
You start the process by determining if you want a standard or itemized deduction from your taxes. The standard option is a flat amount of money, but you won’t have to fill out any extraneous forms. The simplicity is incredible, but there are certain circumstances where you will receive more credit overall if you spend time itemizing your deduction instead. Here is what you can get from a standard deduction based on your filing status.
- $19,400 for heads of households
- $12,950 for single filing status
- $25,900 for married, filing jointly
- $12,950 for married, filing separately
Asking for an itemized deduction will allow you to write off a wide array of expenses on your overall tax bill. Each one comes with a form, and you often need to provide separate proof to validate any claims you make. Tax specialists can help you save quite a bit with an itemized deduction, though keep in mind that their fees will likely increase in proportion to the amount of work you assign to them.
2. Acquire a 1098 Form
Tax Form 1098 is the main page you will be dealing with when applying for the mortgage interest deduction. You can receive this document from your mortgage lender or service provider. You will need to have paid at least $600 in mortgage interest throughout the year to be eligible for the form. The document itself gives you room to detail all the money you have paid in mortgage interest to validate your claims when the tax bill comes due.
3. Choose the Tax Forms That Match Your Situation
You will still need to fill out the standard 1040 Tax Form as well as a Scheduled variant of the document based on your unique circumstances. For instance, most people applying for the deduction will use the Schedule A version of the 1040 form to complete their taxes. However, you may be asked to use Schedule E or C depending on how your mortgage applies to any business ventures you operate. We always recommend checking with a tax professional when picking out the correct forms to use.
What Counts as Deductible Mortgage Interest?
The easiest way to know what you can deduct is to examine a few key items and payments most mortgage owners see throughout the term of the loan.
Interest on Your Main Home
Your primary residence can be any property type, including condo, apartment, mobile homes, and traditional residential setups. The key is to ensure the property has basic living accommodations to qualify. A bathroom, a place to sleep, and a place to prepare food are the basic requirements for this. The home must also be put up as collateral for the loan you took out for it. As long as your property falls within these parameters, you can deduct any interest paid even after selling the home in that same year. Should you take out a home equity line of credit, you can also use any interest paid on that loan for your tax incentive.
Interest on a Second House
A second home may also be used for this incentive, though there are a few considerations. The home must be used as collateral for the loan, and you must live in the home for at least two weeks or 10% of the days you rented out the property that year. Keep in mind that you can only enjoy this incentive on two houses total, so choose wisely if you have a portfolio of properties.
The Mortgage Points You Pay Off
When first buying a home, you have the option of purchasing mortgage points that cost exactly 1% of your total loan each. Each point you pay off will reduce the interest rate of the loan by 0.25%. You can pay these points at the time of closing, and then you can write them off at the end of the year when the tax bill arrives. In some cases, you need to distribute the savings over the course of a loan. Talking to tax experts is the best way to determine if this is the case for your loan.
Prepayment Fees
Some lenders will penalize you for paying down your mortgage early as it costs them some profit on interest. When this happens, you can at least add the prepayment fees to your itemized deductions. Keep in mind that the benefit of paying off the mortgage early may or may not be worth it, depending on the fees. Be sure to analyze the terms of the loan and calculate your best option before choosing to pay down large amounts of mortgage debt at once.
Late Payment Penalties
If you happen to miss a payment on your mortgage and get charged a late fee, you can save some money on the error by writing it off. You may as well do this if you find yourself with a late payment, but your goal should be to never miss a payment in the first place. Late payments affect more than just your cash. Your credit score will take a hit, and this can lead to many detrimental effects.
What Expenses are Non-Deductible?
Unfortunately, some items are non-deductible and must be added to your taxable pool. Here are a few things you can expect to pay for when the bill comes due.
- Closing costs, such as title and recording fees
- Homeowners insurance premiums
- Down payments, deposits, and earnest money that you forfeited
- Interest paid on a reverse mortgage plan
- Mortgage insurance and VA funding fees
- Moving expenses (unless you are an active duty service member)
- Rent paid before you owned the home
A Few Special Circumstances to Consider
Since houses come in all forms, there are several special circumstances that alter the rules of what can count as mortgage interest for your deduction. Here are some of the most common examples of when unique rules are drafted.
- Homes sold as part of a timeshare can be treated as your second home for the deduction.
- A house that was destroyed or is still under construction may qualify for some credit.
- A newly divorced or separated couple can choose to split the deduction both ways.
- Homes with a single room rented are seen as a living space.
- Co-op apartment owners can deduct their share of the building’s total mortgage.
Take the Next Step With American Business Credit
When traversing the complex world of tax forms and mortgage interest deductions, having a professional by your side is crucial to getting the most savings on your return. At American Business Credit, we help you understand the terms and stipulations of your loan before you sign anything. With the proper guidance and support, purchasing property does not have to give you a headache. In fact, you may be surprised by just how much you can save with the right tax plan in place.
