If you own a home, one of your first questions may revolve around how your home affects your tax filing. While there have been some changes in recent years, come tax time, it’s important to know exactly what qualifies as a deduction (and to consult with your tax advisor) so you can get the most out of your tax write-offs.*
What Is the Mortgage Interest Deduction?
A mortgage interest deduction is an itemized tax deduction that allows homeowners to deduct the interest paid on a loan used to buy, build, or improve a first or second home. Please know that deductions may vary by state - consult your tax advisor for questions about these deductions. Homeowners who purchased a home prior to December 15, 2017 can deduct interest on the first $1,000,000 of mortgage debt. For those who purchased a home after December 15, 2017, a deduction only applies to the first $750,000 of mortgage debt.
How the Mortgage Interest Deduction Works
There are many nuances to the mortgage interest deduction, so make sure you keep good records of the interest you’ve paid throughout the year. Here’s a look at some things to watch out for and know as you’re evaluating your deductions.
- As noted above, you can deduct all the interest you paid on up to $1,000,000 in a mortgage loan, but you can only deduct up to the first $750,000 of home loan debt if you purchased the property after December 15, 2017.
- For example, if you bought a home in 2016 and you have $1,000,000 in debt on that home, you can deduct all of your mortgage interest. However, if you bought a home with the same loan amount in 2018, you can only deduct interest on $750,000 according to the 2017 Tax Cuts and Jobs Act.
- However, there is an exception to the new limit. If you entered into a written contract for a property before December 15, 2017 and closed on the property before April 1, 2018, you are exempt and can deduct your interest on up to $1,000,000 in mortgage debt.
What Qualifies As Mortgage Interest?
The type of mortgage in question (e.g. a first or second mortgage) and the type of property it covers, such as your primary residence versus an investment property, can affect how your mortgage interest deduction works, so you’ll want to know how it relates to your specific case this year. For a complete list of rules and regulations, make sure to check out IRS Publication 936. Here is a brief overview of a few common scenarios below.
Mortgage Interest For Your Home
In order to deduct the mortgage interest on your home, you must meet a few qualifications. First of all, the home must be a house, apartment, condo, co-op, houseboat, mobile home or trailer, and it must have sleeping, cooking and bathroom facilities. The home itself must be collateral for a mortgage loan.
If you receive a nontaxable housing allowance via the military or because you’ve done ministry work, you can still deduct interest. If you have taken out another mortgage to buy out a partner in a divorce as part of a mortgage buyout, you can also deduct the interest on that mortgage.
Mortgage Interest For Your Second Home
You can deduct mortgage interest on your second home, but in order to do so, there are a few rules. You don’t have to use the home during the year, but the home must be collateral for a loan. Also, if you rent out the home and receive rental income on the property, you must be in the house for more than 14 days or more than 10% of the days the home is rented, whichever is longer.
Any Points Paid On Your Mortgage
If you paid points on your mortgage loan as a way to pay down the amount of your loan interest, you can deduct these either all at once, or over the course of the loan, but there are a few requirements. The loan must be for your primary home, and paying discount points must be a regular practice where you live.
Also be aware of the interest rates on the points, which can’t be deducted if they were used for closing costs. Your down payment must be higher than your points, and the points must be calculated as a percentage of the loan.
Home Equity Loan Interest
The interest on your home equity loan is only deductible if you are using the loan to make significant repairs to your property. If you are using the loan for another purpose — a large purchase, paying down debt, etc. — it is not deductible.
Late Payment Charges On Your Mortgage
If you’re late making a mortgage payment and are charged a late fee, this additional cost counts as part of the mortgage interest deduction.
For some lenders, paying off your loan early can result in a prepayment penalty (but not when you have a loan with Pennymac) because lenders want to ensure they’re getting interest income. If you are charged a prepayment penalty for any reason, you are allowed to deduct this as part of your mortgage interest deduction.
What You’re Not Able to Deduct
Not all extra costs associated with a mortgage are deductible. Here’s a look at what doesn’t qualify:
- Mortgage insurance premiums
- Homeowners insurance
- Any interest accrued on a reverse mortgage
- Down payments, deposits, or forfeited earnest money
- Title insurance
- Extra principal payments made on your mortgage
- Settlement costs (typically)
How to Claim Your Mortgage Interest Deduction for 2019
Getting ready to prepare your taxes and want to make sure you’re taking full advantage of your mortgage interest deduction this year? It’s important to make sure all your paperwork is in order and follow these steps to take full advantage of the deduction.
Look Out For Form 1098
This form shows how much you paid in mortgage interest and any points for the tax year. Your lender will send you the form if you paid $600 or more in mortgage interest, and they will also send a copy to the IRS to match up with your return. This form may also show you the amount of interest you’ve paid on your home loan to date. Can’t find it or not sure if you received it at all? Just contact your lender, and they can provide you with the amount of mortgage interest you paid for the year.
Itemize Your Taxes
If you want to take advantage of the mortgage interest deduction, you’ll need to itemize your deductions instead of using the standard deduction. Make sure it makes sense to itemize your deductions, as the goal is to take the highest possible deduction available to you.
Instances Where You Can Claim the Mortgage Interest Deduction
There are some scenarios where you can still claim the deduction even if your situation doesn’t fit the standard requirements exactly. Just make sure you’re keeping extremely accurate records of all of your property costs throughout the year, as well as square footage used for spaces like rentals and home offices, as things can get even more complicated. Here are some cases that would allow you to still claim the deduction.
- The home was a timeshare
- You rented out part of your home.
- You had a home office. (Make sure you track the square footage, and you may even be able to claim an additional deduction using Schedule C.)
- The home was an apartment co-op.
- Your home was under construction.
- Your home was destroyed within the applicable tax year.
- You and a partner split and you’re now paying a mortgage on a home you both own.
Mortgage Interest Deduction 2018
The 2018 U.S. tax bill made significant changes to the mortgage interest tax deduction, as well as other updates for homeowners.
Mortgage Tax Bill Changes
The mortgage interest deduction allows homeowners to deduct part of the cost of their mortgage on their taxes. The 2018 tax plan now limits the portion of a mortgage on which you can deduct interest to $750,000, as compared to the previous limit of $1 million. Homeowners with mortgages that existed prior to the bill’s passage can continue to receive the current deduction.
Property Tax Deduction Changes
When looking at the 2018 tax changes, the focus was typically on the mortgage interest deduction changes. The bill has another aspect that affects homeowners: With the changes in property tax deductions, the 2018 tax plan has a limit of $10,000 on the amount of state and local property taxes that can be deducted from a homeowner’s federal taxes.
Know Your Tax Advantages With Homeownership
Whether you already own a home or are taking your very first steps toward making a smart investment in a home to call your own, be sure to stay in the know about all the potential tax advantages, along with the many other benefits of homeownership.
*Consult a tax adviser for further information regarding the deductibility of interest and charges.