Filing Your Income Taxes

Mortgages & Taxes: What You Need to Know

Mortgages & Taxes: What You Need to Know
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The interest you pay on your home loan can be tax deductible on your federal return, but there can be a limit to the amount you can claim. The deduction isn't quite as good as it was before ​2018​, and you have to itemize to claim it. This can present some drawbacks.

What Is a Mortgage?

Most people have to take out a loan to buy a home. Ideally, you’ll be pre-approved before you start shopping. The process of preparing the loan begins after you qualify and commit to buying a certain property. You’ll close on your mortgage loan about a month or so after you have a signed contract to buy the property.

You'll finalize the paperwork and pay closing costs on this date. Homeowners are typically required to make a down payment toward the loan in addition to paying closing costs.

You’ll then make monthly payments on the loan until you either sell the property or pay the mortgage off. Your monthly mortgage payment will include a portion of the overall amount you borrowed, called “the principal,” plus interest, and it may include homeowner’s insurance and property taxes as well.

The Mortgage Interest Tax Deduction

The mortgage interest deduction is the most significant of home-related tax breaks. You can deduct the interest on mortgages of ​up to​ ​$750,000​ if you took out your loan after ​Dec. 15, 2017​. This drops to ​$375,000​ if you're married and you file a separate tax return. The limit increases to ​$1 million​ or ​$500,000​ for mortgages finalized before this date.

You can deduct all the interest you pay during the year if you took out the mortgage on or before ​Oct. 13, 1987.​ This is referred to as grandfathered debt. You can also deduct all the interest if you took the mortgage out after this time and the funds were used to "buy, build or substantially improve" your home. A cash-out refinance won't qualify if you use the additional funds to pay for your wedding or pay your child's college tuition.

You might refinance your mortgage at some point to lower your payment. The limit on how much interest you can claim in this case is based on your original loan’s date, no matter when you refinance. You can only deduct interest up to the amount of the original mortgage and any extra money you borrow in a cash-out finance must be used to improve the home.

You can also claim the interest on a home equity loan you might take out to pay for home improvements. This includes home equity lines of credit. This additional debt will count toward your total interest deduction limit of $750,000 or $1 million in indebtedness.

You might reduce the interest you’ll pay over the life of your mortgage by buying “discount points” at the time when you close on the house. You’ll receive a discount of ​1 percent​ on interest for each point that you guy. Discount points are deductible, too, but be sure to separate them from loan origination points you pay at closing. Origination points are actually lender fees so they aren’t deductible.

Read more:What Are Mortgage Points?

Other Homeowner Deductions

Interest isn’t the only thing that’s potentially tax deductible on your federal return. You can also claim a deduction for property taxes you pay. You'll probably pay your property taxes through your mortgage as a portion of your monthly mortgage payment. You can deduct up to ​$10,000​ in property taxes you pay per year, or ​$5,000​ if you're married and filing a separate return.

You may have been required to buy private mortgage insurance if you made a down payment on your home of less than ​20 percent​. The deductibility of PMI has been off and on over the years, but it’s alive and well for tax year 2021. This is the return you'll file in 2022. You can also retroactively claim any amounts you paid toward PMI in ​2018​ and ​2019​ during the time when it wasn’t deductible.

Read more:Is PMI Tax Deductible?

Your mortgage payment will usually include a month’s portion of the overall amount you borrowed, called “the principal,” as well as interest and your homeowner’s insurance and property taxes.

Itemizing vs. Standard Deduction

Some homeowners may never claim a mortgage interest deduction because itemizing isn't the best option for everyone. You can either claim the standard deduction you're entitled to for your filing status or you can itemize your deductions, but you can't do both. Many taxpayers find that their standard deduction is more than all their itemized deductions combined. Itemizing would mean being taxed on more income than necessary in this case.

The standard deduction increased a great deal when the Tax Cuts and Jobs Act went into effect in 2018, so it can be harder to surpass with itemized deductions. It was ​$12,550​ in ​2021​ (the return you'll file in 2022) for single taxpayers and for married individuals who file separate returns, increasing to ​$25,100​ for married taxpayers filing jointly. It was ​$18,800​ for those who qualify for the head of household filing status. The standard deduction is indexed for inflation so it keeps pace with the economy, and it increases to ​$12,950, $19,400​ and ​$25,900​ respectively in tax year 2022.

It’s usually a good idea to crunch the numbers both ways to see whether itemizing or claiming the standard deduction gives you the best tax advantage.

The Secured Debt Requirement

You can only take the mortgage interest deduction if your mortgage is classified as a secured debt. Your home acts as collateral for your mortgage loan. The lender can foreclose and seize your property if you don't make mortgage payments. Your mortgage loan must use your home as collateral to qualify for the interest deduction.

Mortgage Interest on a Second Home

The property must also be your main home or primary residence, with some exceptions. It can't be a vacation property or summer home. But you may still qualify to claim the mortgage interest deduction if you rent the home out for a portion of the year. The IRS rule is that you must live in the residence for either ​14 days​ longer or ​10 percent​ longer than the period of time during which it was rented to a tenant or tenants over the course of the year.

How to Claim the Deduction

You should receive a Form 1098 from your lender shortly after the first of the new year if you paid ​$600 or more​ in mortgage interest during the tax year. The form will detail the mortgage interest you paid, the outstanding mortgage principal, any refunds on overpaid interest you received, any PMI premiums you paid and any points you paid when you took out the loan.

Enter the amount from box 1 of Form 1098 on line 8a of Schedule A, the tax form you must use to itemize your deductions. Enter the amount on Line 8b if you didn't receive a Form 1098 from your lender for some reason, but it's usually advisable and much less trouble to just reach out to your lender and get that form.