When The Mortgage Interest Deduction Is Not Beneficial
A single taxpayer in the same 24% tax bracket also wonders if itemizing taxes would result in a lower tax liability. The taxpayer paid $9,700 in mortgage interest for the previous year and only has $1,500 of deductions that qualify to be itemized. The standard deduction for a single taxpayer for 2021 is $12,550. Because the total itemized deductions is slightly less than the standard deduction, it does not benefit the taxpayer to itemize for the tax year.
Essentially, the homeowner receives no benefit for the paid interest, and the mortgage interest deduction goes unclaimed.
What Portion Of Your Mortgage Is Tax
Know that the principal portion of your mortgage payment is not tax-deductible. Only the portion of your payment that goes toward interest is tax-deductible.
However, there are some other mortgage-related fees you can claim when you purchase or improve a rental property. These include
- Mortgage applications, appraisals, processing, and insurance fees
- Your mortgage guarantee fees
- Mortgage brokerage and finderâs fees
- Legal fees related to mortgage financing
Tcja & Understanding Changes To Mortgage Interest Deduction
The Tax Cuts and Jobs Act of 2018 changed both the type of mortgage interest that can bededucted as well as the amount ofinterest that can be deducted.
AcquisitionDebt vs. Equity Debt
AcquisitionDebtis incurred in acquiring, constructing, or substantially improving anyqualified residence of the taxpayer andmust be secured by the taxpayer’s residence.
EquityDebtis all other debt secured by the taxpayer’s residence, such as home equityproceeds that are used to pay off credit card debt, purchase a vehicle, take avacation, etc.
Under the TCJA, all equity debt is non-deductible, even if incurred prior to December15, 2017.However, if the proceeds fromhome equity debt are used to buy, build, or substantially improve the propertythat secures the debt, the debt can be considered acquisition debt.Acquisitiondebt is deductible, but different rules apply depending on the date itwas incurred.
NewLimits
For mortgages acquired after December 15, 2017, taxpayers can write off interest paid onindebtedness of $750,000 or less.Ifmortgage indebtedness exceeds $750,000, only a percentage of the interest canbe deducted.
Example: A taxpayer purchases a house for $1 millionand closes escrow on 12/31/17.Hesecures a mortgage of $800,000.He isentitled to deduct interest on only $750,000 of the mortgage because the debtwas incurred after 12/15/17.He will receive no tax benefit for theinterest paid on the other $50,000 portion of the loan.
GrandfatheredDebt
RefinancingGrandfathered Debt
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Tax Deductions And Refinancing
The IRS allows you to deduct the interest paid on up to $1 million in mortgage debt, on either your primary or secondary home, or the two combined. So if you have a $750,000 mortgage on your primary home and $250,000 mortgage on a vacation home, you can deduct all your mortgage interest.
That doesn’t change after refinancing, so you can refinance one or both mortgages and still deduct all your mortgage interest, as long as the combined mortgage principle does not exceed $1 million for a couple, or $500,000 for a single filer.
Do: Itemize To Claim Your Mortgage Interest Deduction
The personal exemption put in place by the TCJA has risen for tax year 2021 to $25,100 for married couples filing jointly. This increased standard deduction may or may not make it worth your while to itemize your return to get the break the mortgage interest deduction can bring. As has been the case last year, TCJA made things a bit more complicated as there is also a $10,000 limit on deducting State and Local Taxes .
If the total of the two total more than $25,100 , it’s probably worth it to itemize your return, but there’s no simple answer as to whether it is or isn’t.
As an example, if you are in a high-tax state and will hit the $10,000 SALT cap, that leaves you with $15,100 gap to fill with mortgage interest before you get over the threshold where itemizing may make sense. For a married couple with a mortgage at 3%, you’ll need a loan amount of $510,000 to have paid $15,100 in interest in the first year of the loan.
Since interest costs diminish over time from there, hitting this mark in future years can be increasingly difficult. For example, the amount of interest paid in the second year of the loan example above totals only $14,831, so you’ll need other deductible expenses to help close the gap.
So, is it worth it to itemize your return or not? You have to run the numbers to find out, or let your tax professional figure it out for you. If it is worth it, you’ll be filing a 1040 Schedule A.
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Payments Must Be Applied To Deduct Interest
If youre not making a payment, then Internal Revenue is not going to get a report from the reverse mortgage servicing department that interest is being paid, explained Diaz. In order to claim the interest, you have to be making a payment.
In another scenario, where a borrower does not choose to make any payments on the reverse mortgage loan on accrued interest, that persons heir can claim the amount of interest they paid on the loan.
If the heirs pay off the interest on a reverse mortgage after the borrower dies, they can claim it in the year that they pay it, says Michael Darrett, a CPA at Chicago, Ill.-based Liberty Tax Services.
But, he adds, there are still limitations, as the amount of interest claimed cannot exceed $100,000. This is the limit on the amount of debt that can be considered home equity debt, which is how the IRS views reverse mortgage loans.
Other Mortgage Payments You Can Deduct
Some types of payments related to paying your mortgage can be included as interest for the purpose of claiming the deduction. The most common payment you can deduct is your private mortgage insurance premiums. This deduction was initially eliminated by the Tax Cuts and Jobs Act of 2017, but recent legislation brought it back.
Report these payments as if they were interest payments at the time you file your taxes, using Schedule A, Itemized Deductions, for Form 1040.
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Pro #: You May Lower Your Current Mortgage Interest Rate
Typically, this is the main motivator behind refinancing. If you originally got your mortgage when interest rates were high, and youve never refinanced, you may be paying more than you need to. Taking the time to apply for a new loan at a lower rate could save you hundreds of dollars a month.
For example, if you have a $200,000 loan and are paying 7 percent interest on a 30-year fixed-rate mortgage, your total monthly interest and principal payments are probably about $1,331. If you refinanced at 3.8 percent, your monthly payment could be reduced to $932. Thats a monthly savings of $399!
Who Gets To Take The Deduction
You do, if you are the primary borrower, you are legally obligated to pay the debt and you actually make the payments. If you are married and both you and your spouse sign for the loan, then both of you are primary borrowers. If you pay your son’s or daughter’s mortgage to help them out, however, you cannot deduct the interest unless you co-signed the loan.
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A Note On Mortgage Tax Deductions
Refinance loans are treated like other mortgage loans when it comes to your taxes. You may be able to deduct certain costs, like mortgage interest, but only if you itemize your deductions. If you take the standard deduction , then your mortgage refinance wont affect your taxes one way or another.
Only 31% of U.S. taxpayers itemized their deductions in 2017, according to the Tax Policy Center. And even fewer did so in 2018, following new tax laws. The website smartasset reckons, In 2017, 47.1 million taxpayers itemized deductions, relative to 15.3 million in 2018.
So does refinancing affect taxes? Only for relatively few taxpayers. And typically only a bit.
Con #: Refinancing Can Be Expensive
Before you get started, make sure you know how much it will cost to refinance. Generally, refinancing costs between 3 and 6 percent of the loans principal. Therefore, its important not to be tempted to spend too much money refinancing if you know you wont live in the home long enough to recoup the costs.
Ask yourself these questions before moving forward: how long do I plan to live in this house? How much money will I save by refinancing? The answers to these questions will help determine if refinancing is worth it.
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How The Mortgage Interest Deduction Works
The name says it all: The mortgage interest deduction allows you to deduct only the interestnot the principalyou pay on your mortgage.
Lets say your monthly mortgage payment is $1,500. You dont get to deduct $1,500. Look at your mortgage statement and youll see that perhaps $500 of your payment goes toward principal and $1,000 goes toward interest. The $1,000 is the part you can deduct.
The interest you pay decreases slightly each month, with more of your monthly payment going toward principal. So your total mortgage interest for the year isnt going to be $12,000 it might be more like $11,357 or $12,892.
In the later years of your mortgage, that same $1,500 payment may put $1,000 toward your principal and only $500 toward interest. The mortgage interest deduction saves you more in the early years.
A Portion Of Property Rented Out For Part Of The Year
Here, the percentage of mortgage interest eligible for the deduction becomes even smaller. For example, perhaps you decided it was best not to have a roommate in your condos second bedroom during the pandemic and so you re-occupied that space as of April 1, 2020. In that case, you would first calculate the size of the second bedroom as a proportion of the total condo suite, and then divide that percentage by four, since the rental took place for just one-quarter of the year .
Note that in all cases, it is only the interest payments on the mortgage that are included in the deduction calculations. The portion of your mortgage payment that goes toward paying down the original debt , is not an eligible expense. If youre not sure what your mortgage interest payments are, refer to your annual mortgage statement.
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What Counts As Mortgage Interest
Deductible mortgage interest is any interest you pay on a loan secured by a main home or second home that was used to buy, build, or substantially improve your home. For tax years prior to 2018, the maximum amount of debt eligible for the deduction was $1 million. Beginning in 2018, the maximum amount of debt is limited to $750,000. Mortgages that existed as of December 14, 2017 will continue to receive the same tax treatment as under the old rules. Additionally, for tax years prior to 2018, the interest paid on up to $100,000 of home equity debt was also deductible. These loans include:
- A mortgage to buy your home
- A second mortgage
- A line of credit
- A home equity loan
If the loan is not a secured debt on your home, it is considered a personal loan, and the interest you pay usually isn’t deductible.
Your home mortgage must be secured by your main home or a second home. You can’t deduct interest on a mortgage for a third home, a fourth home, etc.
How Does A Refinance In 2021 Affect Your Taxes
It used to be that being a homeowner could offer some big tax advantages, not the least of which are perks related to that mortgage you pay every month. With the Tax Cuts and Jobs Act changing certain aspects of the tax code starting a few years back, it’s much less of a certain thing than it used to be.
If you refinanced your mortgage in 2021, there are some specific “dos” and “don’ts” you need to know prior to filing your income taxes, as well as a few pointers that might help you lower your tax bite.
What follows may help to reduce your federal income taxes and get you prepared for mortgage-related tax issues in 2021 and beyond.
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Intangible Taxes May Be Deducted
Additionally, reverse mortgages in some states like Florida, the intangible fee can also be claimed.
The key thing would be, make sure the borrower saves their final settlement statement when they close, for when tax time comes, says Diaz. Sometimes the IRS doesnt get everything reported correctly, and you have to have all your ducks in a row.
These deductions can all be listed on Schedule A of a 1040 from, he says.
While one of the perks of getting a reverse mortgage is not having to make a monthly payment, for those who wish to control their balance, making interest paymentsis something to consider. However, its important to note that this doesnt mean a borrower can claim the interest that accrues on the loan, unless they pay it off.
Heres what the IRS has to say: Any interest accrued on a reverse mortgage is not deductible until you actually pay it, which is usually when you pay off the loan in full.
If you do pay the interest, though, its fair game for tax deduction.
Deducting Interest From A Heloc Or Home Equity Loan
Equity is the current value of your home minus how much you have left on your mortgage. If your home is worth $300,000 and youâve made $50,000 in payments against the mortgage principal, you have $50,000 in equity.
You can receive part of the equity as cash without selling your home, by using it as collateral for a home equity line of credit or a home equity loan.
Whether you take out a HELOC or a home equity loan, the interest may be deductible just like ordinary mortgage interest. As with mortgage interest, the HELOC or home equity loan debt must be secured by a qualified home âif you default on the HELOC or home equity loan, your home could go into foreclosure, meaning you could lose the home.
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Your Mortgage Interest Deduction Limit
Since the Tax Cuts and Jobs Act took effect, the limit on mortgage interest deductions has decreased. Prior to 2018, the mortgage interest deduction limit was $1 million. Now that the limit has been lowered, taxpayers who are single or married and filing jointly may only deduct up to $750,000 of interest. For married couples who file separately, the limit is now $375,000 each. However, there are certain exceptions to these new rules:
- Grandfathered debt. If you took out a mortgage before October 13, 1987, you can deduct all of the interest that you pay. There is no limit because youve been grandfathered in.
- Home acquisition debt. If you took out a mortgage to purchase a home after October 13, 1987 but before December 16, 2017, you can deduct up to $1 million .
- Home equity debt. If you took out a second mortgage after October 13, 1987 but before December 16, 2017, for any reason other than to build or improve your home , you can deduct interest on mortgage amounts up to $100,000 .
Can I Deduct My Homeowners Insurance And Pmi
Unfortunately, you cant deduct your homeowners insurance but you are able to deductprivate mortgage insurance. Although you can deduct the interest you pay on a primary and secondary residence, a home equity loan, prepaid mortgage points and prepayment penalties, not all of the payments you make qualify as mortgage interest. In fact, most of your home expenses cant be deducted. Heres a list of other common home payments that arent tax-deductible:
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Loans That Are Exempt
When you borrowed the money is also important. Home loans taken out before October 14, 1987, are exempted from some rules. You may fully deduct interest paid on these loans, regardless of their size or what you used them for. Any refinanced debt you incurred before October 14, 1987, is rolled into your total acquisition indebtedness.
On loans made on or after October 14, 1987, you can deduct mortgage interest paid on acquisition indebtedness up to a total of $1 million . This means you could buy a home for $250,000, a beach home for $200,000, and add a family room to your first house for another $100,000, and still have $450,000 to spend on these homes for further improvements before you reached your limit for interest deductibility. The $1 million is not cumulative.
Your equity indebtedness limit is $100,000. That means that you can borrow up to $100,000 of the equity in your home and use it for whatever you want. This is a change from the pre-1986 tax rule that limited your equity borrowing beyond the purchase price to certain qualified expenses, such as home improvements, medical and education expenses.
Are Closing Costs Tax Deductible In 2021
Can you deduct these closing costs on your federal income taxes? In most cases, the answer is no. The only mortgage closing costs you can claim on your tax return for the tax year in which you buy a home are any points you pay to reduce your interest rate and the real estate taxes you might pay upfront.
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Does Refinancing Affect Taxes
Unfortunately, theres no cutanddry answer here. Refinancing may or may not affect your taxes, depending on what type of refinance you used and how you file.
As a general rule, your mortgage only impacts your taxes if you itemize your deductions.
And, if you used a straightforward rateandterm refinance, there likely arent any tax implications. A cashout refinance could have some, but you will not have to pay income tax on the equity you cashed out. Heres what you should know.
The Mortgage Reports is not a tax site. This information is for general guidance only. Consult with a tax professional about your specific situation.
