Mortgage Tax Deductions You Should Know about this Season

Homeownership is touted as part of the American dream for a reason. When you own your home, you’re in charge, free of dealing with landlord issues and rent increases. It gives you a sense of independence you just can’t get when you rent.

In addition to giving you equity and allowing you to customize your living space in ways rentals don’t allow, owning your own home can also come with tax benefits.

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Mortgage tax deductions save you money by reducing your taxable income—the portion of what you earn that the government (federal, state, and local) collects taxes on.

In order to claim mortgage tax deductions, you’ll need to itemize. When you file your taxes, you have the choice between claiming the standard deduction, which for the 2021 tax year is $12,550 for single filers and $25,100 for married couples filing together, and itemizing deductions. If the total amount of deductions you are eligible for is greater than what your standard deduction would be, it makes sense to itemize.

If you crunch the numbers and decide that itemizing is the right choice for you, and you own your home, these are some mortgage tax deductions that could save you money.

Mortgage interest

The most substantial of the mortgage tax deductions is the interest deduction. 

When you make a mortgage payment, that monthly amount includes both principal and interest (and sometimes also includes property taxes and homeowners insurance).

You can deduct the amount you pay in interest on your mortgage on your taxes, within certain limits. If you bought your home before December 16, 2017, you can deduct the interest paid on your first $1 million of mortgage debt every year. If you bought your home after that date, you can deduct the interest paid on the first $750,000 of mortgage debt.

This deduction applies to any mortgage debt you have, including your primary home and second home, if you have one. The $750,000 limit includes both homes. If you rent out your second home, the interest on that mortgage debt is only deductible if you spend at least 14 days or 10% of the time you rent it out at the home each year, whichever is greater.

There are a few other expenses that you can count as mortgage interest for the sake of tax filing:

Interest paid on a home equity line of credit (HELOC) or home equity loan, if it meets certain conditions

HELOCs and home equity loans are two different ways you can borrow against the equity in your home for temporary cash.

You can deduct the interest paid on a HELOC or home equity loan, but only if you use the money you borrow to buy a home, build a home, or make significant renovations to your home.

Private mortgage insurance (PMI) premiums

If you make a down payment of less than 20%, or if you use certain types of mortgages like an FHA loan, you may have to pay a PMI premium. PMI protects the lender in case you are unable to continue making mortgage payments.

The IRS treats PMI premiums as mortgage interest, so you can deduct the amount you paid on your tax return. This deduction was set to expire at the end of 2020, but it was extended as part of COVID-19 relief.

Mortgage points

When you close on your home, you can purchase mortgage points to reduce the interest rate on your loan. Mortgage points are also known as prepaid interest. Generally, you pay the fee to the lender, with one point costing one percent of the mortgage amount.

You can deduct mortgage points as mortgage interest either the year you pay them or over the life of the loan, depending on your circumstances.

Other fees

Some mortgages charge prepayment penalties if you pay off your loan before the end of the original term. For example, if you took out a 30-year mortgage and paid it off in 25 years, you might owe a prepayment penalty. These penalties are often deductible as part of the mortgage interest deduction.

You may also be able to deduct any late-payment fees if you failed to make your monthly mortgage payment on time.

Property taxes

Homeowners can deduct state and local taxes (SALT), including property taxes, income taxes, and sales tax, which is a boon to those living in high-tax states like New York and California.

Prior to 2018, taxpayers could deduct the total amount they paid in eligible taxes, but the Tax Cuts and Jobs Act imposed a $10,000 deduction limit.

How mortgage tax deductions can affect your financial situation

After the Tax Cuts and Jobs Act put limits on itemized mortgage tax deductions and nearly doubled the size of the standard deduction, many people found that they’d lower their taxable income more by not itemizing.

Generally speaking, you’ll likely need to be eligible for additional itemized deductions, like charitable contributions or medical expenses, on top of the mortgage tax deductions to make it worthwhile.

Additionally, people with higher incomes benefit more from mortgage tax deductions than those with lower tax brackets. According to the Tax Policy Center: “Deducting $2,000 for property taxes paid saves a taxpayer in the 37% top tax bracket $740, but saves a taxpayer in the 22% bracket only $440.”

Crunch the numbers on your deductions before you decide to itemize and claim the above mortgage tax deductions. And if you still have doubts, contact a certified public accountant or enrolled agent to help.

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