Saving money on a down payment and closing costs has created a barrier for many potential homeowners. To make it a worthwhile debt, incentive programs like mortgage interest tax deduction have been developed that have made it even more attractive for renters to take the plunge and take on the mortgage debt that is required to buy their first home.
Another incentive is the FHA loan, which only requires 3.5% less than the 20% required for a traditional loan. Things have changed since these incentives were introduced. Is the mortgage interest deduction still the incentive it once was? Read on to find out.
What is a Mortgage Interest Deduction?
A mortgage interest deduction is a reported tax deduction that a homeowner can use to deduct interest on a qualifying loan that they are paying for with their taxable income. The loan could potentially be one of the following:
- Mortgage loan
- Home equity loan
- Home Equity Credit Line (HELOC)
- Second mortgage loan
The loan is only eligible if it is being used to build or buy a home, or for significant improvements and updates. Homeowners can apply the mortgage interest deduction for their primary and secondary residence as long as they are not renting out the secondary residence full-time.
Deductions like mortgage interest help people who own a home by lowering their taxable income, which lowers the total amount of tax owed. By offering this deduction, often the largest single deduction you can use, people are encouraged to buy a house instead of paying rent to live in another house.
Before the 2017 Tax Cut and Jobs Act, the mortgage interest deduction was capped at $ 1 million in mortgage debt. After the law went into effect, the cap on homes purchased after December 15, 2017 was lowered to $ 750,000.
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How does a mortgage interest deduction work?
Mortgage interest deduction will only work if you include your deductions on your tax return. Homeowners can claim the mortgage interest deduction in 2021 by reporting the mortgage interest paid in 2020 on Appendix A of their 1040 tax form.
Many homeowners do not have mortgage debt near the $ 750,000 limit on interest deduction. Therefore, the entire amount of interest you paid in 2020 should be deductible if all the requirements are met. When listing your deductions to minimize your taxable income, don’t forget about home equity loans or lines of credit. Interest on these types of loans are also eligible.
You should get a Form 1098 from your mortgage or home equity lender showing how much interest you paid on each type of loan in 2020.
Mortgage interest can be deducted until 2025 according to the Tax Reduction and Employment Act. However, some homeowners may be better off using the standard deduction than listing them when filing their taxes. Another part of the law included increasing the standard deduction from 2019 from $ 6,500 to $ 12,000 for those filing individually, and from $ 13,000 to $ 24,000 for those filing joint feedback.
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How does the mortgage interest deduction help?
The point of deducting mortgage interest was to encourage home ownership. By reducing your total taxable income, you can lower the amount of taxes you pay. This is no different from a landlord who deducts mortgage interest on rental properties in their Appendix E. Tenants do not have an option to deduct interest. So when you make mortgage interest deductible, the risk and expense of buying a home is well worth it.
Before the Tax Cut and Employment Act of 2017, interest wasn’t the only deductible expense. You can also deduct items such as property taxes and percentage points paid on the mortgage.
The law was created to streamline the tax return process and make it easier for individuals to prepare and file their own taxes. However, increasing the standard withholding amounts for single and group applicants has made the need to breakdown deductions unnecessary for many, as the standard withholding reduces their taxable income by more than their listings. The law also limits the amount of state and local taxes (SALT) eligible for deduction to $ 10,000, including property taxes, which are due to expire along with the deduction of mortgage interest in 2025.
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