If you rent an apartment you can probably go ahead and skip to one of our many other articles. They're all written by smart, snappy and devilishly attractive journalists, and you'll actually get something out of them.
Because this article? This one right here is for the people in America that Congress truly loves. That's right, the homeowners. (Well, homeowners and people who graduated college before 2000. So, basically the same people.) It's about the mortgage interest deduction, that section of the tax code that Congress uses to make housing more affordable… as long as you don't rent.
What Is the Mortgage Interest Deduction?
The mortgage interest deduction allows homeowners to deduct the interest they pay on home loans. Those can be any loans used to buy, build or even improve the property; as long as the debt is tied to their personal, residential real estate it probably qualifies.
Note that this does NOT allow you to deduct the value of the loan itself, only your payments on the interest.
It is one of the most popular sections of the tax code. Americans claimed approximately $77 billion in mortgage interest deductions in 2016.
How Does the Mortgage Interest Deduction Work?
There aren't many rules to the mortgage interest deduction. As long as you meet the following requirements, you can claim the deduction:
- You must itemize your taxes.
This deduction is taken on Schedule A of the 1040. If you claim the standard deduction you won't use this sheet and can't claim the mortgage interest deduction.
- The property must be your primary or secondary residence.
Yes, you can take the mortgage interest deduction on up to two properties at once. They must be a residential property, however. You cannot take the mortgage interest deduction on an investment property.
Landlords can deduct the interest they pay on the mortgage for a rental property, however, this must be claimed as part of the property's expenses on Schedule E.
- You must claim the deduction below the principal limit.
You can only deduct the interest on principal up to $750,000. If you have cumulative property debt in excess of that amount, either through a single mortgage or numerous loans, you must split the interest. You can deduct your interest on the qualifying portion of the loan(s) and not the rest.
Borrowers who took out a loan before Dec. 16, 2017 can deduct the interest on principal up to $1 million.
- The loan must be related to and secured by the property.
You can deduct interest for a mortgage you took out to buy, build or even improve your home. However, you cannot deduct unsecured debt, such as a personal loan, even if you used it improve the property. Nor can you deduct debt secured by the property used for an unrelated purpose.
- It doesn't have to be a house though!
You have to have bought the property and done so with a loan secured by the asset. Beyond that, this deduction can apply to anything that the IRS considers a residence, which can include a wide variety of purchases. From apartments to RVs and who knows? Maybe even a fancy bouncy castle. If it meets the IRS' standards for a residence (typically requiring a sleeping, cooking and toilet facility), this deduction applies.
If you succeed at taking this deduction for a bouncy castle expect to host a few guests.
- Home equity debt now conditionally applies.
Borrowers who took out home equity debt prior to Dec. 16, 2017 can deduct the interest on up to $100,000 of principal. Going forward, home equity debt does not apply to this deduction if spent generally.
A home equity loan does apply if used to buy, build or make improvements to the property. (Given the nature of home equity debt, this will almost always apply to improvements.) However, it now counts toward the $750,000 total debt limit for the mortgage interest deduction. It is no longer a separate category.
- You must be the primary borrower.
You can't take this deduction for paying off someone else's loan. You must be the primary borrower, spouses filing jointly or spouses filing separately.
Whew… That seems like a lot, but it boils down pretty simply: If it's your home, and you live there and you pay the mortgage, then you probably qualify for this deduction.
Changes to the Deduction in 2018
The tax bill passed in 2017 changed a few elements of the mortgage interest deduction. Most notably, the cap on this deduction was lowered from $1 million to its current rate of $750,000 for new loans. The home equity section of the deduction was trimmed as well, limiting it to only property-related expenses.
Readers should note that outlets have reported that home equity loans have been entirely disqualified from the mortgage interest deduction. This is only partially correct. The home equity deduction has been eliminated, and with it the additional $100,000 which borrowers can take. However, the IRS has ruled that home equity debt used to buy, build or improve the property constitute a "qualified residence loan." As a result, home equity debt now counts toward the total $750,000 of qualifying principal for this deduction.
Finally, the 2017 tax bill probably made this a tax break exclusively for the rich.
Starting with 2018 income taxes Congress has nearly doubled the standard deduction (but eliminated the personal exemption.) As a result, the IRS expects that only about 5% of W2 filers will take line-item deductions on their taxes. This will reduce the mortgage interest deduction only to that handful of taxpayers wealthy enough to continue itemizing their deductions.
Mortgage Insurance Premiums
If you have mortgage insurance, as many people do if they make a low initial down payment, you may include the premiums in your mortgage interest deduction.
Most economists hate the mortgage interest deduction.
The trouble is that this deduction targets wealthy Americans for a tax break with almost surgical precision.
Unlike an income tax rate cut, the mortgage interest deduction does not return money that the taxpayer earned. It is a structured preference for buying expensive houses. It affects only those taxpayers wealthy enough to buy a home, leaving renters with no assistance from the tax code whatsoever. And as an itemized deduction, this tax break further winnows eligible taxpayers into just those who are wealthy enough not to take the standard deduction.
Approximately three-quarters of this deduction's benefits go to the top 20% of earners.
Economists also point out that this deduction has badly distorted the housing market. It does act as a purchasing incentive, but not toward homes in general. Rather, it incentivizes the purchase and construction of large, expensive houses. This is particularly problematic at a time when affordable housing, particularly in cities, has reached crisis levels.
All of which is why the mortgage interest deduction, despite its popularity, remains controversial.