Filing Taxes? What do You Need To Know About Mortgage Interest Deduction?

Have you mortgaged your home and are relaxed that your mortgage payments will be deducted from your taxable income? Well, you need to think it through. Not all of your mortgage payments are tax deductible and you can only benefit from tax deductibility if you are clear about what gets subtracted to decrease your taxable income for a lower tax payment. Let’s dive in together to learn about the IRS rules and requirements that need to be met for tax deductibility benefits.

What does the Term ‘Mortgage Interest Deduction’ Refer to?

Mortgage interest is the payment you make on your home financing loan. Mortgage interest (not all) can be deducted from your taxable income to give you relief from paying a higher amount of taxes when you are already paying mortgage expenses. You can make better estimates and draw your savings.

Along with your mortgage interest, the mortgage premium and points can also be subtracted from your taxable income, provided the criteria are met. The mortgage payments that you make in a year are deducted from the taxable income of the same year, and this amount should be calculated based on the interest payment and not the principal amount of the loan. Further, the itemization of your payments is crucial for the deduction to get accepted by the authorities.

Although the mortgage interest deduction is not a new concept, the variations in rules and deductible amounts have and are continuously changing. Due to an ever-rising homeownership rate, the authorities keep on decreasing the limits of the tax-deductible amounts. It is important to keep in the loop to claim the acceptable amounts and attain the associated advantages.

What Counts as Mortgage Interest?

According to the IRS, 'mortgage interest' is the interest on a loan secured by a qualified home. This qualified home could be your primary or secondary home. The interest payments on the mortgage or home equity loan, taken to buy, develop, or improve your primary residence or second home, are tax deductible.

The home can be any type of property, like a condo, apartment, mobile home, boat, or any such vehicle. To call the place a home, the prerequisites include sleeping, cooking, and eating spaces and amenities.

Not only interest payments can be subtracted to lower your taxes, but there are other expenses as well that come under the umbrella of mortgage interest deduction. Let’s discuss those.

• Non-rented Second Home Interest
  
  If you are using the property for more than 14 days or longer than 10% of the rented-out duration, you can take away that interest from your taxable income, provided you fulfill the requirements.


• Fees for Late Payments
  
  If you are penalized for paying your mortgage beyond the due date, you can deduct this fee from your taxable income when computing your mortgage interest deduction.


• Prepayment Penalties
  
  You can deduct the amount of any financial penalties you incur for paying off your mortgage earlier than required from your taxable income.


• Points
  
  Point payments are often made by borrowers to attain a lower interest rate. If you are one of those borrowers, you can decrease your taxable income for the year by the amount of points you paid for the same filing year.


• Home equity loans and home equity lines of credit
  
  If you took out either a home equity loan or home equity line of credit (HELOC) to pay for a home improvement project, you can deduct the interest on the amount you used to upgrade your property.

• Homeowners Insurance
• Extra principal mortgage payments
• Title insurance
• Settlement or closing costs
• Deposits, down payments, appraisal fees, notary fees, or earnest money that you forfeited
• Accrued interest on a reverse mortgage
• Mortgage insurance premiums - There are some exceptions for certain types of loans and certain income levels.
• Accrued interest on a third or fourth home.
• A home equity loan money/HELOC funds - The money utilized for reasons that cannot be associated with the home.

• Communicate with your Lender
  
  Your lender is responsible for tracking the amount of interest you have paid. He will provide you with ‘Form 1098’ at the start of the calendar year. This form shows the amount of interest you paid on your mortgage loan. It may also include information about other deductible costs, such as mortgage points or fees.


• Itemized Deductions versus the Standard Deduction
  
  After receiving Form 1098, you need to determine whether to itemize your deductions on your federal income tax return or opt for the standard deduction. You can compare the two options using a Schedule A form.
  
  You must itemize all of your deductible expenses, including your mortgage interest, property taxes, charitable contributions, and medical costs. Alternatively, the standard deduction amount is the allowed deductible amount which differs as per the taxpayer’s filing status, age, and other relevant variables.
  
  If your itemized deductible costs are greater than the standard deduction limit, it can be financially beneficial to itemize and claim the mortgage interest deduction. However, if your calculations show otherwise, it is better to opt for the standard deduction. The purpose is to reduce the taxable income and taxes and maximize the gains.


• Form 1098
  
  If you decide to itemize your deductions, you will need to give your Form 1098 to your tax professional to report the amount of mortgage interest paid during the year. This form is necessary to accurately claim the deduction and should be included with the homeowner's tax return.
  You can also complete Schedule A on Form 1040 by yourself. You can record the reported mortgage interest in 8a, unreported interest in 8b, and insurance premiums in 8d.

• Copies of Form 1098 - Mortgage Interest Statement
• Closing statement - Home or refinancing
• Information about the buyer of your home
• Federal tax return from the previous year

• Office Space in the Home
  
  If you use a part of your property for a home office, only the portion used for living qualifies for a mortgage interest deduction. You will have to calculate the square footage that is being used for residential purposes.


• Home Under Construction
  
  According to the guidelines, constructing your own qualified home gives you a 24-month period for qualification.


• Home Sales
  
  You can deduct interest accrued on the loan up to the date (not including that date) of sale if you sold your home last year.


• Points for Refinancing
  
  If your refinancing was done in 2021, and you made points payments to decrease your interest rate, you can subtract some amount from your taxable income spread over the duration of the new loan.


• Second Home Rentals
  
  You should have used your second home yourself for more than 14 days or 10% of the rented-out days.


• Pre-settlement Payments
  
  You cannot deduct the payments made during the pre-settlement period when you are purchasing the home. As you are living in that house, the payment would be considered rent, even if settlement papers label them as interest, and hence is non-deductible.


• Destructed Home
  
  Any unforeseen accidents, damages, or destruction of your home won’t take away your eligibility for tax deductibility. However, you need to rebuild and live in it or sell the land within a specific time.


• Loan Proceeds for Business Purposes
  
  If you are utilizing the mortgage money for business purposes, and you are a sole proprietor, the interest on the loan is recorded on Schedule C. If the money is being utilized to buy a rental property, the interest would be recorded on Schedule E.


• Rental Property Loans
  
  Interest paid on a loan taken against a rental property is not tax-deductible, as the collateral is not the potential home itself.


• Loans for Tax-exempt Investments or Insurance
  
  You cannot deduct mortgage interest if you used a home mortgage to purchase tax-exempt securities, single-premium life insurance, or annuity contracts.


• Co-op Apartment Ownership
  
  If you own a co-op apartment, you are eligible to subtract your portion of interest of the building mortgage.


• Timeshare
  
  Considering other standard requirements, you can decrease your taxable income by the amount of interest you pay on the timeshare home by regarding it as a home or second home.