Especially during the early years of your loan term, your home mortgage interest can make up most of your mortgage payments and quickly add up so that you see little change to your loan principal. To account for mortgage interest expense, the Internal Revenue Service allows taxpayers who itemize to get the home mortgage interest deduction.
While this tax benefit can work for various types of homes, there are limits and rules to follow, and taking the mortgage interest tax deduction can require different processes depending on your situation. Take a look at this mortgage interest deduction guide to learn all about the basics.
Understanding the Mortgage Interest Deduction
The home mortgage interest deduction serves as a way to reduce your taxable income by letting you subtract your mortgage interest paid during the tax year. The IRS also includes points and mortgage interest within this deduction. You can take the home mortgage interest deduction alongside other itemized deductions, such as the property tax deduction, to help you get the most tax savings for your qualifying home.
For example, consider that you paid $12,000 in mortgage interest on your home in 2020, had an adjusted gross income of $50,000 and decided to itemize. Thanks to the home mortgage interest deduction, your taxable income would go down to $38,000 (your AGI minus the interest expense). Plus, you can increase your itemized deductions further with other things like charitable donations, property taxes, medical expenses (over the 7.5 percent AGI limit) and state and local taxes paid.
While you can deduct interest on a qualifying loan of any size, the IRS has set limits so that you may not get to deduct the full amount if you have an expensive home.
Note that this tax deduction only applies if you own part or all of the property and have taken out a loan personally that is secured to the property. So, for example, you can't deduct mortgage interest if you pay someone else's mortgage and live in their home as a nonowner. You also need to meet various criteria, such as the type of home and mortgage, as well as be aware of current limits on the loan principal (mortgage debt) for which you can deduct the interest.
2020 Mortgage Interest Deduction Limits
While you can deduct interest on a qualifying loan of any size, the IRS has set limits so that you may not get to deduct the full amount if you have an expensive home. Before 2018, when the Tax Cuts and Jobs Act took effect, you could have a $1 million mortgage and deduct all your interest paid on that amount of principal during the year.
Since the tax changes have taken effect, you can now only deduct the mortgage interest you paid on loans of up to $750,000 (most filing statuses) or $325,000 (married filing separately) if you purchased the property after December 15, 2017. The good news is that the earlier $1 million limit (halved to $500,000 for married filing separately) is available if you bought your house before that deadline. And if you bought it prior to October 13, 1987, then you don't have to worry about a limit at all since the IRS grandfathers such borrowers in.
Note that the pre-TCJA mortgage limit could go back into effect for all taxpayers in 2025 when the law is set to expire.
Rules on Qualifying Properties
To make sure you can take the home mortgage interest deduction, the property for which you're deducting interest needs to be a primary or second home. The IRS is flexible in that it allows for various structures, such as a standalone house, houseboat, trailer, condo or even a co-op, to be considered a home for the deduction. However, it has some specific rules on your use of the properties.
For example, your primary residence needs to be livable and have appropriate facilities to use the toilet, sleep and cook. If you don't use the entire house as a residence – for example, maybe you have a home office – then you have to allocate the deduction appropriately as well as fill out separate tax forms for the residential versus business uses.
When deducting a secondary home, it's not required for you to be physically at the property that tax year, but the IRS no longer considers the place a personal residence if you rent the home out and don't meet one of the criteria. Specifically, the IRS will check that you've either lived there two weeks during the tax year or lived there 10 percent more days than others rented it. If the rental usage goes beyond that, then you'd have to deduct mortgage interest as a rental property expense rather than take the personal deduction for that home.
Qualifying Mortgage Loans
For your mortgage to qualify for the home mortgage interest deduction, it has to be considered "home acquisition debt," and this can include original and refinanced mortgages along with home equity loans if certain criteria are met. However, interest paid on reverse mortgages doesn't qualify as deductible. In any case, that primary or secondary home needs to be the collateral for the mortgage you took out. Then, you need to have either used the mortgage to buy or build the place or to add major, permanent improvements to it.
For example, if you took out a $300,000 mortgage to have a primary residence built or you spent $500,000 to purchase an existing home to use as your secondary residence, these mortgages would qualify. It gets trickier, though, when you're dealing with a refinance or home equity loan where you may have used funds for something other than your home.
A home equity loan would qualify if you used the money to build onto your home, but not if you just paid off credit cards and your car loan with the money. If you used a cash-out refinance, you couldn't deduct interest on that money if you used it for a vacation or just minor home repairs. On the other hand, adding a swimming pool or new roof with the funds would qualify as major capital improvements and allow for the mortgage interest deduction.
Rules for Points and PMI
Paying points when you take out your mortgage can help you save on interest throughout your loan's life, and the IRS treats them as interest you've prepaid. This money you spent is deductible just like regular mortgage interest, but you need to meet a long list of IRS criteria to deduct the whole point value at once for the corresponding tax year for which you paid the cost. If you can't meet that criteria, you have to spread the cost over the loan's term, which means taking small deductions each year.
One of the main criteria is that you took the mortgage on a property where you reside most. The points need to be paid for interest and not other things like taxes, and you need to have clear documentation of how the points were calculated. While there are several more rules, a few others deal with whether the points paid were normal and a usual amount for where your property was, what payment source you used for the points and if you used a cash accounting method.
Along with deducting points, you can deduct PMI premiums. Although the practice expired after 2017, Congress has allowed an extension so that those filing their taxes through the 2020 tax year could get this tax benefit. You can deduct the whole PMI amount reported on the tax forms that your lender sends you.
Preparing to Deduct Mortgage Interest
Now that you know the rules and limits to taking the home mortgage interest deduction, you should first determine whether itemizing on your income tax return suits your tax situation, especially since the standard deduction has risen considerably since the TCJA. If you're single and the mortgage interest is the only deduction you have, consider that you'd get a $12,400 standard deduction in 2020, which may be far more than the interest paid on your home. If you and your spouse file together, that would mean a $24,800 standard deduction. So, it helps to determine your deductible interest to decide.
To get an idea of your mortgage interest, points and PMI paid, you can consult Form 1098, Mortgage Interest Statement. Around late January to early February, you should receive this form from each lender as long as your mortgage interest was at least $600. You can still deduct the qualified interest if you don't get that form, but that would mean finding more documentation and would likely mean your mortgage interest deduction would be far less than taking the standard deduction.
When looking at Form 1098, you find your mortgage interest paid in box 1. Box 5 shows mortgage insurance premiums, while box 6 shows any points paid that year. You can find the mortgage acquisition date in box 3 in case you need to check to determine your limits for the year. If you've added up your mortgage interest deduction along with all your other itemized deductions and determined you'd be better off than taking the standard deduction, you can proceed with filling out your tax return forms to report the expenses.
Deducting Interest As Typical Homeowner
If you're a typical homeowner who doesn't have a qualified home office and your home doesn't qualify as a rental property per IRS rules, then deducting your home mortgage interest is a straightforward process once you have your Form 1098 and any other documents showing mortgage interest paid. The IRS form for reporting your itemized deductions is Schedule A, and you need to complete this before you can move the deduction over to your 1040 return.
You use the third section of Schedule A to input your home mortgage interest information. Use line 8a to put the mortgage interest and points you had reported on a 1098 form and line 8d to list any PMI premiums. If you have qualified mortgage interest not shown on a 1098 form, you use lines 8b and 8c to list the interest and points separately. After tallying up 8a to 8d, you have your total mortgage interest deduction amount.
You can continue working through Schedule A to report deductions such as charity gifts, local and state taxes, casualty and theft losses as well as dental and medical expenses. You can then tally everything up to get a final figure on line 17. Once you have all your itemized deductions calculated, you can simply transfer that number to Form 1040 line 9.
Deducting Interest in Special Situations
If you reside in your home but have a part set aside for business use, then you need to adjust your home mortgage interest deduction so that you split the interest for the business and personal parts of the home. When filling out your Schedule C, you'd use the standard method for deducting home office expenses and put the business portion of home mortgage interest paid on line 16a. You could then fill out Schedule A as discussed to account for the remaining amount as a personal itemized deduction.
Read More: Guide to Home Office Deductions
If you have a rental property (beyond the IRS allowance for renting personal residences), then you complete Schedule E to report your rental income alongside all related expenses. There's a place to enter the mortgage interest expense on line 12. You wouldn't qualify for the regular mortgage interest deduction for that property on your Schedule A, but you could take the deduction for a qualifying primary residence.
- IRS: Publication 587, Business Use of Your Home
- IRS: Schedule C
- IRS: Form 1040
- IRS: Schedule A
- IRS: Publication 936 (2019), Home Mortgage Interest Deduction
- Tax Foundation: The Home Mortgage Interest Deduction
- NerdWallet: Mortgage Interest Deduction: What Qualifies in 2020
- IRS: Changes to the Deductibility of Mortgage Insurance Premiums (MIP)
- Rocket Mortgage: How to Claim Refinance Tax Deductions
- IRS: Topic No. 504 Home Mortgage Points
- NerdWallet: Standard Tax Deduction: How Much It Is in 2020 and When to Take It
- Credit Karma: Can I Claim the Mortgage Interest Deduction if I Don’t Have Form 1098?
- IRS: Form 1098
- IRS: Schedule E
Ashley Donohoe has written about business and technology topics since 2010. Having a Master of Business Administration degree, bookkeeping certification and experience running a small business and doing tax returns, she is knowledgeable about the tax issues individuals and businesses face. Other places featuring her business writing include Zacks, JobHero, LoveToKnow, Bizfluent, Chron and Study.com.