What Is Home Mortgage Interest Deduction?
The Home Mortgage Interest Deduction allows eligible taxpayers to reduce their taxable income by deducting the interest paid on a qualified home mortgage. This tax incentive falls under the broader category of personal finance and taxation within the U.S. federal income tax system. It aims to make homeownership more accessible and has historically been a significant itemized deductions for many homeowners, directly impacting their overall tax liability. To claim the Home Mortgage Interest Deduction, taxpayers must file Form 1040 and itemize their deductions on Schedule A.
History and Origin
The concept of deducting interest expenses has been a component of U.S. federal income tax law since its inception. When the modern income tax was enacted in 1913 through the Revenue Act of 1913, it permitted deductions for all interest paid. This broad allowance included interest on home mortgages, effectively establishing the Home Mortgage Interest Deduction as a long-standing feature of the tax code.4 Over the decades, the deduction has evolved through various legislative changes, most notably with the Tax Reform Act of 1986, which formalized the definition of qualified residence interest, and more recently, the Tax Cuts and Jobs Act of 2017.
Key Takeaways
- The Home Mortgage Interest Deduction allows taxpayers to deduct interest paid on qualified mortgage debt for a primary residence and one second home.
- The Tax Cuts and Jobs Act (TCJA) of 2017 significantly changed the limits for loans taken out after December 15, 2017.
- To claim the deduction, taxpayers generally must itemize deductions on Schedule A of their tax return.
- The deductible amount is subject to specific debt limitations, which depend on when the mortgage was incurred.
- Interest on home equity loan or lines of credit is only deductible if the funds are used to buy, build, or substantially improve the home that secures the loan.
Interpreting the Home Mortgage Interest Deduction
The Home Mortgage Interest Deduction is interpreted as a reduction in a taxpayer's adjusted gross income, leading to a lower overall taxable amount. For taxpayers, a higher amount of deductible mortgage interest can translate into significant tax savings, especially for those in higher tax brackets.
However, the benefit of the Home Mortgage Interest Deduction depends on several factors, including the taxpayer's total mortgage debt, the prevailing interest rate on their loan, and whether their total itemized deductions exceed the standard deduction amount for their filing status. Understanding the interplay between these elements is crucial for effective financial planning.
Hypothetical Example
Consider Sarah, a single taxpayer who purchased her principal residence in March 2018 with a mortgage of $600,000. For the tax year, she paid $20,000 in mortgage interest. Sarah itemizes her deductions.
Under the rules established by the Tax Cuts and Jobs Act of 2017, the Home Mortgage Interest Deduction limit for new loans taken out after December 15, 2017, is $750,000 of qualified acquisition indebtedness. Since Sarah's mortgage is $600,000, it falls below this limit. Therefore, Sarah can potentially deduct the full $20,000 in mortgage interest paid on her income tax return, provided she itemizes her deductions and this, combined with other eligible deductions, exceeds her standard deduction for the year.
Practical Applications
The Home Mortgage Interest Deduction is a key consideration in individual financial planning and real estate decisions. For prospective homeowners, the potential tax savings from the deduction can influence affordability calculations and mortgage choices. It factors into budgeting and long-term wealth management strategies, particularly when evaluating whether to buy a home or determining appropriate mortgage amounts.
In the broader context, the Home Mortgage Interest Deduction has been viewed as a form of government subsidy for homeownership, influencing housing markets and credit markets. Taxpayers can find detailed guidance on claiming this deduction in IRS Publication 936, which outlines eligibility criteria, limitations, and how to report the interest on tax forms.3
Limitations and Criticisms
Despite its widespread use, the Home Mortgage Interest Deduction has faced criticisms regarding its equity and efficiency. One common criticism is that the deduction disproportionately benefits higher-income households and those with more expensive homes, as these individuals typically have larger mortgages and are more likely to itemize their deductions.2 Conversely, lower-income individuals or those who take the standard deduction receive no benefit from the Home Mortgage Interest Deduction.
The Tax Cuts and Jobs Act (TCJA) of 2017 significantly reduced the maximum amount of mortgage debt eligible for the deduction from $1 million to $750,000 for new loans, also suspending the deduction for interest on home equity loans unless the loan proceeds are used to buy, build, or substantially improve the home.1 These changes have curtailed the benefit for many taxpayers and reflect an ongoing debate about the deduction's role in promoting broad-based homeownership and fostering economic growth.
Home Mortgage Interest Deduction vs. Standard Deduction
The Home Mortgage Interest Deduction is an itemized deduction, meaning it is one of several specific expenses that taxpayers can subtract from their adjusted gross income if they choose to itemize rather than take the standard deduction. The Standard Deduction is a fixed dollar amount that taxpayers can subtract from their adjusted gross income if they do not itemize.
The key difference lies in the choice taxpayers must make: they can either claim the sum of their eligible itemized deductions, which may include the Home Mortgage Interest Deduction, or they can claim the standard deduction, whichever results in a lower taxable income. For many, especially since the TCJA increased standard deduction amounts, the standard deduction provides a greater tax benefit than itemizing. The decision hinges on whether the total of one's itemized deductions, including mortgage interest, state and local taxes, and charitable contributions, exceeds the applicable standard deduction amount for their filing status.
FAQs
What types of homes qualify for the Home Mortgage Interest Deduction?
The deduction generally applies to interest paid on a mortgage for your principal residence and one second home. Both homes must meet certain criteria, such as having sleeping, cooking, and toilet facilities.
Can I deduct interest on a home equity loan or line of credit?
Under current law, interest on a home equity loan or line of credit is only deductible if the funds were used to buy, build, or substantially improve the home that secures the loan, and the total debt, including your primary mortgage, does not exceed the allowed limits. Using funds for personal expenses like credit card debt or vacations typically does not qualify for the deduction.
How does refinancing affect the Home Mortgage Interest Deduction?
If you refinancing your mortgage, you can generally continue to deduct interest on the new loan up to the amount of the old mortgage debt. If you borrow more than the original mortgage, the interest on the additional amount is only deductible if the new funds are used to substantially improve the home, and the total debt remains within the allowed limits.
What are the current limits on the Home Mortgage Interest Deduction?
For mortgages taken out after December 15, 2017, the total deductible mortgage debt for a principal residence and a second home combined is limited to $750,000 ($375,000 if married filing separately). For mortgages taken out on or before December 15, 2017, higher limits of $1 million ($500,000 if married filing separately) apply.