Buying a home has never been more expensive, but if you can find a home you can afford, there’s some good news after you move in: You may be able to take advantage of the mortgage interest deduction to lower your tax bill.
However, the IRS rules regarding the mortgage interest deduction can be very complex. As you look ahead to tax season, here’s a guide to help you understand the eligible benefit of the deduction and how you can benefit if you qualify.
What is the mortgage interest deduction?
If you have a home loan, the mortgage interest deduction may allow you to reduce your taxable income by the amount of interest paid on the loan during the year, along with some 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 need to itemize your deductions. You can use Bankrate’s Mortgage Interest Discount Calculator to get an estimate of the type of savings you can expect when you file your taxes.
The mortgage interest deduction has been around for over 100 years, but it has changed over time. Various administrations have modified the rules for this benefit, and the impact of former President Donald Trump’s tax reform on who can benefit.
Mortgage interest deduction limit
If your home was purchased before December 16, 2017, you can deduct the mortgage interest paid on your first $1 million in mortgage debt ($500,000 if you were married separately).
For mortgages obtained since that date, you can only deduct interest on the first $750,000 ($375,000 if you are married separately). Note that if you were under contract before December 15, 2017, and the mortgage closed before April 1, 2018, your mortgage will be considered to have been made prior to December 16, 2017.
Taking the mortgage interest deduction for your 2021 tax filing
While nearly all homeowners are eligible for a mortgage interest tax deduction, you can only claim this if you itemize your deductions on your federal tax return by filing a Schedule A with Form 1040 or equivalent form.
For this reason, you will have to determine if the mortgage interest deduction is best by determining or taking the standard deduction. The standard deduction for tax year 2021 is $12,550 for single applicants and $25,100 for married taxpayers who file a joint application. For tax year 2022, these amounts rise to $12,950 for single applicants and $25,900 for married participants.
Let’s say you’re a single homeowner who spent $18,000 in mortgage interest in 2021. It would make sense in this scenario to separate your deductions, as you would reduce your taxable income by a larger amount than if you were to take the standard deduction.
If you are unsure of the best path to take, consult a tax professional to help you understand the best course of action for your financial situation.
What is the qualification for a mortgage interest?
The IRS’ general definition of “mortgage interest” is the interest owed on any loan secured on your primary or second home. There are other costs and fees that can be included in the mortgage interest deduction as well. Here’s the rundown:
—Any interest on your home: The property must include sleeping, cooking and dining facilities and can be a home, apartment, co-op, motorhome, boat or RV.
Interest in a second home that you don’t rent – If you rent the property for a certain period of the year, you’ll need to meet certain guidelines (specifically, use it for your personal use for longer than 14 days or more than 10 percent of the time rented, whichever is longer) to deduct interest. Be sure to read about other tax deductions for rental property.
—— Most Mortgage Insurance Premiums: For tax year 2020, if your adjusted gross income (AGI) is more than $109,000 as a couple or $54,500 if you apply individually, you cannot deduct mortgage insurance costs.
Late Payment Fee: If you are late in paying, you can probably deduct the additional fee that you were charged.
—Prepayment Penalties: If you are charged a penalty for paying your mortgage early, you can deduct this amount.
—Points: If you pay points for a lower mortgage interest rate, you can deduct a portion of it that applies to the individual year of filing.
Home Equity Loans and Equity Lines of Credit Used to Improve Your Home: If you take out a Home Equity Line of Credit (HELOC) or a home equity loan to pay for a home renovation project, you can deduct interest on the amount you used to upgrade your property.
What is non-deductible?
Interest on a third or fourth home mortgage
No interest on a reverse mortgage
Closing costs or down payment
Additional payments towards capital
—Home Equity Loan Funds/HELOC funds used for purposes not related to your property (eg if you borrow against your home to pay for a wedding, this money is not deductible)
Special Considerations for Deducting Mortgage Interest
When you review the IRS’ guide to mortgage interest deduction, you’ll notice a lot of language explaining exceptions in certain situations. Below is a partial list of those special considerations. If you have a unique circumstance, see the latest IRS version 936 or seek guidance from a tax professional.
—Home office complications: If you’re using a portion of your property for a home office, you’ll need to calculate the exact square footage used for living versus working. The “living” space is the only part that qualifies for the mortgage interest deduction.
Home Under Construction: If you are building a home, you have a qualifying 24 month period under the Mortgage Interest Deduction Guidelines.
—Home sales: If you sold your home last year, you are still allowed to deduct the interest accrued on the loan until — but not including — the date of the sale.
Pay Points When You Refinance: If you refinanced your mortgage in 2021 and paid points to lower the rate, you likely won’t be able to deduct the full cost of those points. Alternatively, you may be able to deduct a portion of these points over the life of the new loan.
How to claim a mortgage interest deduction
Step 1: Monitor communications from your lender or provider in early 2022. You don’t have to keep track of how much interest you’re paying; The lender or provider will take care of this and send you the Form 1098. This should arrive near the end of January or sometime in early February, and should also include your mortgage insurance premiums and any prepaid interest.
Step two: Calculate. You will need to determine if itemizing your deductions (the mortgage interest fee and any other eligible deductions) will give you an amount greater than the standard deduction.
Step 3: Submit Form 1098 to the tax professional, or complete Schedule A on Form 1040 yourself. All reported mortgage interest will be entered on line 8a, anything not reported will appear on line 8b and the mortgage insurance premiums will appear on line 8d.
Mortgage Deduction Benefits
The main advantage of the mortgage interest deduction is that it can reduce the total tax you pay. Let’s say you paid $10,000 in mortgage interest and are within a 32 percent tax bracket. You’ll reduce your tax bill by $3,200 after subtracting the $10,000 deduction from your income.
“Those in higher tax brackets will benefit the most as they will see greater discounts,” notes Kelly Crane, president and chief investment officer at Napa Valley Wealth Management, based in St. Helena, California.
In fact, lower-income taxpayers generally get less benefits, explains Andrew Latham, certified personal finance consultant and managing editor at SuperMoney in Santa Ana, California.
“Taxpayers who make less than $100,000 actually get only 11 percent of the benefits from this deduction,” Latham says, citing a 2019 Tax Foundation report. “In contrast, taxpayers who earn $200,000 or more annually get more interest — 60 percent of total savings from the mortgage interest deduction.”
Need more information about filing your taxes in 2022? Read Bankrate’s guide for the upcoming tax season. If you are fortunate enough to qualify for a refund, also consider some great ways to invest that chunk of money to enhance your financial well-being.
(Visit the Bankrate website at bankrate.com.)
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