Deductions on Taxable Income for Mortgage Interest Payments
Purchasing a home is one of the most significant financial decisions that an individual makes in their lifetime. It requires a considerable amount of funds and a long-term commitment to paying off the mortgage loan. However, the good news is that homeowners can enjoy tax deductions on their mortgage interest payments, which can significantly reduce their taxable income.
In this article, we’ll dive deep into what mortgage interest payments are, why they are deductible, and how you as a homeowner can take advantage of these deductions.
What are Mortgage Interest Payments?
When you take out a mortgage loan to buy or refinance your home, the lender charges you an additional fee known as “interest” on top of your principal payment. The interest rate varies depending on several factors such as credit score, down payment amount, and economic conditions at the time of application.
Mortgage interest payments refer to the amount paid by homeowners towards this interest component every month during their repayment period. For example, if you have taken out a 30-year fixed-rate mortgage with an annual percentage rate (APR) of 3%, your monthly payment will consist of both principal and interest components.
Why are Mortgage Interest Payments Deductible?
The Internal Revenue Service (IRS) allows homeowners to deduct their mortgage interest payments from their taxable income under certain circumstances. This deduction was introduced with the primary objective of encouraging more people to invest in real estate by reducing their overall tax burden.
Under current laws set forth by Congress in 1986’s Tax Reform Act (TRA), taxpayers who itemize deductions may deduct eligible home-mortgage-interest expenses up to $750000 for mortgages acquired after December 15th in 2017.
How Does it Work?
To claim your mortgage interest deduction when filing taxes annually with IRS Form 1040 Schedule A:
1. Itemizing Deductions – This means that instead of taking standard deductions, you will have to itemize all your eligible expenses in categories such as medical bills, charitable donations, state and local taxes paid etc.
2. Eligibility Criteria – The IRS sets specific eligibility criteria for taxpayers to claim mortgage interest deductions. One of the requirements is that the mortgage must be secured by a qualified residence which may include your primary home or second home.
3. Calculation of Deductions – Homeowners can deduct interest on mortgages up to $750000 on homes purchased after December 15th in 2017. If you bought your house before then, then the cap is $1 million dollars instead.
4. Documentation – It’s essential to keep accurate records of your mortgage payments throughout the year so that when it comes time for tax season; you have everything organized and ready.
5. Other Tax Benefits- In addition to mortgage interest deduction; homeowners might also qualify for other tax benefits like property taxes deduction if they meet certain criteria set forth by the IRS.
What are Some Exceptions?
As with any tax rule, there are always exceptions and limitations around what can be claimed as an eligible expense under mortgage interest deductions:
1) Renting out your Property – If you rent out a portion or all of your property during any part of the year, then only a percentage of the mortgage interest payment will be deductible based on how much of the property was used for personal use versus rental income generation purposes.
2) Refinancing Your Mortgage Loan- When refinancing a loan homeowners must consider several factors as not all costs associated with refinancing may be deductible such as appraisal fees or title insurance premiums.
3) HELOC Interest Payments – While homeowners may still take advantage of this benefit via their first-lien mortgages, new restrictions apply to second-lien loans (or home equity lines-of-credit), where deductibility now depends on how proceeds are used — no longer simply whether they’re secured against one’s household.
4) Other Exceptions- Homeowners may not claim mortgage interest deductions if they have taken out a home equity loan that exceeds the fair market value of their property or if they are subject to Alternative Minimum Tax (AMT).
Conclusion
Mortgage interest payments are one of the significant expenses for homeowners who have taken out a mortgage loan. However, by claiming this tax deduction, homeowners can reduce their taxable income and save thousands of dollars in taxes every year. It’s essential to be aware of the eligibility criteria, exceptions and limitations around this benefit so that you can make informed decisions about your finances. Talk to your tax advisor or financial planner today if you have any questions regarding mortgage interest deductions!