Mortgage interest deduction explained

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Homeownership has long been part of the American Dream and opens the door to benefits like mortgage interest deduction for those who itemize deductions on their taxes. Itemizing usually only makes sense if itemized deductions on a primary and secondary residence total more than the standard deduction, which nearly doubled in 2018.

Here’s what you need to know about mortgage interest deduction.

Related: A Homeowner’s Guide to HELOC Loans

What is the mortgage interest deduction?

The deduction allows retailers to recognize the interest they pay on a loan related to the construction, purchase or improvement of a principal home against taxable income, thereby reducing the amount of taxes owed. The tax deduction also applies if you pay interest on a condominium, co-op, mobile home, boat, or recreational vehicle used as a residence. The deduction can also be made on second home loans, as long as it remains within the limits.

States with income tax may also allow homeowners to claim mortgage interest deduction on their state income tax returns, whether or not they itemize their federal returns.

What are the rules and limits?

The passage of the Tax Cuts and Jobs Act of 2017 changed the game for the deduction of mortgage interest. From 2018 until 2025, the law significantly increased the standard deduction and removed or restricted many itemized deductions. For the 2020 tax year, the standard deduction is $ 24,800 for married couples filing jointly and $ 12,400 for singles and married individuals filing separately.

If you itemize the deductions, you are good to go and can deduct the interest. There is more good news, as you can also deduct interest on a home equity loan or line of credit, as long as it was used to buy, build, or significantly improve your home. The loan must be secured by the taxpayer’s primary or secondary residence and meet other requirements. For tax purposes, a second home not used for income is treated much like the primary residence. It’s a house that you live in from time to time.

The IRS considers a second home rented part of the time to be one that you use for more than 14 days, or more than 10% of the number of rental days (whichever is greater). If you use the home you rent for less than the required number of days, it is considered rental property – property you never live in and is not eligible for mortgage interest deduction.

Typically, your interest-only mortgage is 100% deductible, as long as the total debt is within limits. According to the Internal Revenue Service, you can deduct mortgage interest on the first $ 750,000 ($ 375,000 if you are married and file separately) of the debt. Higher limits ($ 1 million, or $ 500,000 if marriage is separated) apply if you deduct mortgage interest from debt incurred before December 16, 2017.

You can only deduct mortgage interest if the following conditions are met.

  • You must complete Form 1040 or 1040-SR and itemize the deductions on Schedule A (Form 1040)
  • The mortgage must be secured debt on a qualifying home in which you have an interest

Simply put, your mortgage is secured debt if you put your home as collateral to protect the interest of the lender. If you cannot pay the debt, then your home can serve as payment to the lender to settle the debt. A qualified residence is your primary or secondary residence. The house can be a house, a condo, a co-op, a mobile home, a trailer or a barge. It must have facilities for sleeping, cooking and toilets.

Be aware that the interest you pay on a mortgage on a home other than your primary or secondary residence may be deductible if the loan proceeds were used for business, investment, or other deductible purposes. Otherwise, it is considered a personal interest and is not deductible.

How much can I deduct?

You probably want the answer to that question. In most cases, you can deduct all of your mortgage interest. The amount you can deduct depends on the date of the mortgage, the amount of the mortgage, and how you use the mortgage proceeds.

The IRS says that if all of your mortgages fall into one or more of the following three categories at any time during the year, you can deduct all of the interest on those mortgages. (If a mortgage matches more than one category, add the debt that matches each category to your other debt in the same category.)

  1. Mortgages that you took out on or before October 13, 1987 (called grandfathered debt). Mortgages that you (or your spouse, if married, jointly deposit) took out after October 13, 1987 and before December 16, 2017 to buy, build or significantly improve your home, but only if, throughout 2020, these mortgages plus acquired debt amounted to $ 1 million or less ($ 500,000 or less if the bride and groom file separately).
  2. (There is an exception. If you entered into a written contract before December 15, 2017 to complete the purchase of a principal residence before January 1, 2018 and you purchased the residence before April 1, 2018, you are considered to have contracted the acquisition debt of the house before December 16, 2017.)
  3. Mortgages that you (or your spouse, if you are married) took out after December 15, 2017 to buy, build or significantly improve your home, but only if, throughout 2020, those mortgages plus any grandfathered debt totaled $ 750,000 or less ($ 375,000 or less if married, separate deposit).

The dollar limits for the second and third categories apply to combined mortgages on your primary residence and secondary residence.

What are the special circumstances?

Sometimes life is not black or white, but gray. Just as you need to understand your home loan options, you need to know the specific situations in which the IRS says you may or may not qualify for the mortgage interest deduction.

You can deduct these items as mortgage interest:

  • Late payment fees if it was not a specific service provided as part of your mortgage loan
  • A mortgage prepayment penalty, provided the penalty is not for a specific service rendered or costs incurred in connection with your mortgage

You cannot deduct the interest paid for you if you were eligible for mortgage assistance payments for low income families under section 235 of the National Housing Act.

Is everything deductible?

The government is only so generous. There are a lot of costs associated with home ownership. Many of them are not tax deductible by virtue of the mortgage interest deduction, such as home insurance premiums. One caveat: you may be able to deduct some of the insurance, as well as utilities, repairs, and maintenance if you have a home office and deduct those expenses on Schedule C.

Title searches, moving expenses, and reverse mortgage interest are also not on the list to include in the mortgage interest deduction. Since the interest on a reverse mortgage is due when the property is sold, it is not tax deductible.

How to claim mortgage interest deduction

A retailer will file Schedule A, which is part of the standard IRS 1040 tax form. Your mortgage lender should send you an IRS 1098 tax form, which shows the amount of interest you paid in the tax year. Your loan manager should also provide this tax form online.

Using your tax form 1098, find the amount of interest paid and enter it on line 8 of Schedule A of your income tax return. It’s not a heavy task, but it gets a bit more complicated if you are making income from your property. If you own a vacation home that you rent most of the time, you’ll need to use Schedule E. Additionally, if you’re self-employed and writing off business expenses, you’ll need to enter payments interest on Schedule C..

Take-out

You can benefit from the mortgage interest deduction if you itemize the deductions on your taxes. Keep in mind that this is usually only worth taking if the write-offs exceed the standard deduction. The mortgage interest deduction, however, can be a kind of bonus, especially if you own a second home. As with all matters that affect your taxes, you’ll want to consult your financial advisor to claim the deduction.

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This article originally appeared on SoFi.com and was unionized by MediaFeed.org.

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