Filing Your Income Taxes
The Internal Revenue Code is all in favor of homeownership, and the IRS offers a few tax breaks associated with property taxes and mortgages. One of these is the mortgage interest deduction.
The deduction allows you to subtract from your taxable income the amount you pay in interest – although not toward your mortgage’s principal balance. The end result is that you’re taxed on less income. The mortgage interest deduction has actually been available for more than a century, but it underwent some changes beginning in the 2018 tax year.
One provision remains unchanged, however: mortgages on a second home still qualify, subject to somewhat complicated rules.
Mortgages on a Second Home
The IRS is pretty clear that mortgage interest paid on a second home is deductible, but this presumes that you don’t rent out the residence. Otherwise, you don’t have to personally spend a single night in the home to claim the mortgage interest deduction if you don’t rent it. You never even have to set foot in the place at all.
The rules for claiming the deduction are the same as for your primary residence, as long as you don’t have a tenant. Your mortgage’s principal balance can’t exceed what you paid for the home, which can happen with some refinances or home equity loans. The loan can be secured by either your primary home or your second home. You’re limited to claiming the interest on no more than two homes total.
The home doesn’t technically have to be a house, either. It can be a condo, a trailer or even a boat, as long as it has cooking, sleeping and toilet facilities.
If You Rent the Property
Claiming the mortgage interest deduction becomes more complicated if you rent the home out at any point during the year. You’ll lose the deduction if you don’t personally spend at least 14 days in residence in this case, or for more than 10 percent of the number of days you rented it out, whichever is more.
The IRS also has a rule in place for circumstances where you meet the above residency requirements while you’re just renting out a single room or a portion of your home. This, too, counts as renting. Now you must figure out how much of your mortgage interest is attributable to your part of the property, and how much should be allocated to your tenant’s living space. For example, your deduction would be limited to 75 percent of the interest you paid if 25 percent of your property is dedicated to your tenant’s use.
Read More: How to Rent Your House Out to the Government
Exceptions to the Usual Rules
You can claim your tenant’s portion of the property as your own living area, even if you’re rarely there because it’s your second home, under three circumstances:
- You don’t rent different parts of your home to more than two unrelated tenants during the year, although you can rent to two or more individuals who live together. Otherwise, this makes you a landlord subject to different tax rules.
- The tenant uses their portion of the home solely for residential purposes.
- The rented area doesn’t have its own toilet, sleeping and cooking facilities. It can’t be “self-contained.”
All these rules must be met collectively. Meeting just one or two criteria won’t work.
And here’s a bit of good news if you don’t meet these rules: You can claim the full amount of your mortgage interest on either Schedule C or Schedule E of your Form 1040 tax return or the 1040-SR for seniors. This makes it a business deduction, separate and apart from a personal mortgage interest deduction, but it still subtracts from your taxable income. You can also deduct the cost of your tenant’s portion of electricity and utilities if you pay for them, as well as mortgage insurance and property taxes.
The IRS offers one more loophole: You might also be able to deduct the entirety of your mortgage interest if you use the proceeds of the loan for other business or investment purposes. You’d have to divide up the expenses in this case if you use part of the property for business purposes, such as because you maintain a home office.
Check with a tax professional first to be absolutely sure you qualify under any of these loopholes.
Interest on Home Equity Loans
One more rule ties in with the provision that your loan can’t exceed what you initially paid for the property. This might mean that it’s actually a home equity loan, and not all of these qualify for the mortgage interest deduction.
The proceeds from a home equity loan must be used to “buy, build or substantially improve” the secured residence to be deductible. In other words, you would lose your right to claim the deduction if you used the mortgage proceeds to pay for that dream vacation or your child’s first year away at a top-notch out-of-state university.
This is a relatively new rule implemented by the Tax Cuts and Jobs Act in 2018, and it applies through at least 2025 under the terms of the TCJA. The IRS uses the term “acquisition indebtedness,” meaning that the borrowed funds are attributable to purchasing, building or maintaining your property. Maintaining or “substantially improving” would cover expenses such as those associated with remodeling, adding on an addition or even repairing structural damage that your insurance doesn’t cover for some reason.
The TCJA “grandfathered in” some provisions of the home mortgage interest deduction – meaning that you can continue to claim it if you were able to do so before the law went into effect – but not this one. So you might have been happily claiming a deduction for your mortgage interest for years only to find out that it’s no longer available to you after 2018.
How Much Is the Deduction?
Your mortgage interest deduction can also be limited by the amount of your mortgage – at least if you borrowed a significant sum to purchase your dream second home. The TCJA made one more significant change regarding the amount of your loan.
It used to be that this deduction was available on mortgage loans of up to $1 million through 2017. The TCJA decreased this limit to $750,000, which admittedly is still more than sufficient for many homeowners. The dividing date here is Dec. 15, 2017. Your cut-off is $1 million if you bought your second home prior to this date. Otherwise, it’s $750,000.
This limit plummets to $500,000 and $375,000 respectively for tax years 2017 and 2018 going forward if you’re married and file a separate tax return from your spouse.
There’s a wee bit of a loophole to this rule, too, however. You’ll qualify for the entire $1 million if you were under contract to buy the home prior to the December 2017 date, even if you didn’t actually close on the property in 2017. You had until March 31, 2018, to actually close as long as you were under contract in 2017. Otherwise, you might want to seek the help of a tax professional to figure out how much of your mortgage interest you can deduct if your total indebtedness on the loan in question is more than $750,000.
Indebtedness That Exceeds the Threshold
You can only deduct a pro-rata portion of your interest if your loan comes in over the applicable amount – in other words, you can claim the interest that was generated by the first $750,000 of a mortgage loan you took out in 2018 or later, but not on the balance. Otherwise, you can deduct 100 percent of your interest if your loan comes in under this limit and you meet all the other requirements.
The TCJA is slated to expire at the end of 2025, so it’s possible that the $1 million threshold could return at that time – and home equity loan proceeds used for personal reasons might get a nod again at that time as well. But even then, home equity loans are treated differently from regular mortgages. They would have a much lower limit, just $100,000 of indebtedness.
Is It Worth Claiming the Mortgage Interest Deduction?
You might find yourself wondering if it's worth the trouble to claim the mortgage interest deduction for either your primary home or your second home, even if you meet all these rules and qualify for the full deduction. The answer to this can be attributed to the TCJA as well.
This is an itemized deduction. You can itemize your deductions on your Form 1040 tax return, or you can claim the standard deduction for your filing status, but you can’t do both. And the TCJA ramped up standard deductions significantly beginning with its inception in 2018. Here’s what you’re looking at for standard deductions in the 2021 tax year:
- $25,100 if you’re married filing jointly (up from $24,800 in 2020)
- $12,550 if you’re single, or if you’re married and file a separate tax return (up from $12,400 in 2020)
- $18,800 if you qualify as head of household (up from $18,650 in 2020)
It would take a lot of mortgage interest to exceed these amounts, although your itemized deductions aren’t limited to just mortgage interest. They include all manner of expenses you paid during the year, from dental and medical expenses to charitable donations to certain taxes and some casualty, theft and disaster losses. And, of course, you can include the mortgage interest you pay on your primary residence as well.
The point is that the total of all your itemized deductions should exceed the amount of your available standard deduction to make claiming the mortgage interest deduction a viable option. For example, your total overall itemized deductions might work out to $18,000. You’re married and you’re filing a joint return with your spouse, so your standard deduction would be $25,100 in 2021. You’d be paying taxes on $7,100 more in income if you chose to itemize, $25,100 less the $18,000 you have in itemized deductions.
Then again, you’d be better off itemizing and claiming your mortgage interest if you’re single and you paid $13,000 in itemized expenses during the year.
Read More: What Is the Standard Deduction Per Child on Taxes?
How to Claim the Deduction
You must file Schedule A with your 1040 tax return if you decide to opt-in for itemizing. This tax form breaks down and lists all your itemized deductions. Assuming you don’t have to pro-rate any portion of what you paid in mortgage interest, the exact number of what you paid and how much you can deduct will appear in box 5 of the 2021 Form 1098 that your lender will send you – along with a copy to the IRS – after the close of the tax year, usually by February. This assumes you paid more than $600 in interest.
- IRS: Real Estate (Taxes, Mortgage Interest, Points, Other Property Expenses)
- IRS: Publication 527 Residential Rental Property
- Bankrate: Mortgage Interest Deduction – What You Need to Know in 2020
- Block Advisors: Second Home Tax Tips
- Brighton Jones: Can You Still Deduct Interest on a Second Mortgage?
- IRS: Publication 936 Home Mortgage Interest Deduction
- Tax Foundation: The Home Mortgage Interest Deduction
- IRS: IRS Provides Tax Inflation Adjustments for Tax Year 2021
- IRS: Topic No. 500 Itemized Deductions
- IRS: 2021 Form 1098 Mortgage Interest Statement
- IRS: 2020 Schedule A Itemized Deductions
- IRS: 2020 Form 1040 U.S. Individual Income Tax Return
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Beverly Bird has been writing professionally for over 30 years. She is also a paralegal, specializing in areas of personal finance, bankruptcy and estate law. She writes as the tax expert for The Balance.