Mortgage Interest Deductions 101: What You Should Know

Mortgage Interest Deductions 101: What You Should Know

6 min read
Whitney Hutten

Whitney is a real estate investor and personal finance trainer whose vision is to launch 10,000 families on the path toward financial independence.

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After purchasing her first rental in 2002 and hitting a home run, then nearly losing it all on her second deal, Whitney took control and figured out how to invest in real estate the right way. She realized that success must leave clues. So, she studied and replicated the very personal finance and wealth creation strategies the wealthy use to create financial freedom.

Today, Whitney is a partner in $500MM+ of real estate assets, including 5,000+ residential units (MF, MHP, SFR, and assisted living ) and 1,430+ self-storage. Additionally, she has flipped over $3MM in residential real estate and has a solid portfolio of commercial notes. (Don’t tell anyone though… BRRRR investing is still one of her favorite strategies—26 units and counting!)

In 2018, Whitney founded ASH Wealth and the Investor Accelerator Mastermind, where she helps you develop a clear, workable plan that gives you the results you dream of, solves your business startup or scaling issues, and drives massive progress toward your real estate and financial goals.

In her spare time, Whitney enjoys trail running, mountain biking, camping, and spending time with her family.

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Whitney’s been featured on the BiggerPockets Blog, BiggerPockets Real Estate Podcast episode #340, BiggerPockets Rookie Show episode #29, BestEver Podcast, The InvestHer Show, The Investing for Good Show, Life Bridge Capital podcast, The Road to Family Freedom podcast, Frenzied to Financial Freedom podcast, Purchase to Profits podcast, and more!

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If you don’t enjoy doing your taxes, you’re not alone. (Sometimes, it even feels feel like hot pokers under the fingernails.) But taxes can be fun when you understand how to make the best of your personal financial situations.

Savvy investors must understand the power of taking all of the deductions you can—legally, of course. These tax deductions can lower your tax liability.

Related: 5 Steps to Successful Real Estate Accounting for Investing Newbies

What is the home mortgage interest deduction?

First, let’s define what a tax deduction is. Tax deductions are expenses you incur through the year that the IRS allows you to subtract from your taxable income. This actually lowers the amount of money you have to pay in taxes.

For homeowners, there can be some big deductions that come along with owning a home, such as the mortgage interest you pay. Bonus!

The mortgage interest deduction was designed to promote homeownership by allowing property owners to take a significant deduction. This itemized deduction allows a homeowner to deduct the interest they pay on a loan against their taxable income. You can deduct interest for:

  • Primary mortgages
  • Secondary mortgages
  • Home equity lines of credit (HELOCs)
  • Home equity loans.

The mortgage interest deduction can also apply if you pay interest on a condo, cooperative, mobile home, boat, or RV used as a residence.

Rules on rentals

There is a catch: The loan must be secured by principal residences, a.k.a a main home or second home that you use through a deed of trust, mortgage, or land contract. Essentially, you can’t deduct interest on your third, fourth, or fifth home—or any property you rent out.

In order to claim this deduction, you must use the property for more than 14 days out of the year or more than 10% of the number of days it’s rented out at fair market value. (Whichever number is larger is the number you’ll need to use.) If you don’t meet this test, you can’t deduct the interest via Schedule A.

Now, if you have rental properties with mortgages, you can deduct the full mortgage interest as a supplemental income “loss” on Schedule E of your 1040 tax form.

What qualifies as a home?

For IRS purposes, a home is a house, condo, cooperative, mobile home, boat, or recreational vehicle that has sleeping, cooking, and toilet facilities. Believe me, I’m still trying to get my tear-drop camper to qualify, but my CPA won’t go for it because it lacks a toilet!

Who can take the mortgage interest deduction?

In many cases, a homeowner can deduct all of their mortgage interest paid as long as they meet all of the requirements:

  • Date of the mortgage
  • Amount of the mortgage
  • How the proceeds are used

More on the rules and limits in a minute.

How can you take the deduction?

This is where the rubber meets the road. Home mortgage interest is reported on Schedule A of your 1040 tax form. Quite often, this single line item deduction is what can help you exceed the standard deduction limit and allow you to pick up other Schedule A deductions.

If you have rentals with mortgages on them you can also deduct mortgage interest as well. You will just deduct this mortgage interest for your rentals on Schedule E (NOT Schedule A).

Related: How to Make $100k a Year with Fixer-Upper Rentals

What are the rules and limitations?

Prior to the 2017 Tax Cuts and Jobs Act, the maximum amount of debt eligible for the deduction was $1 million, and you could generally deduct interest on home equity debt of up to $100,000 ($50,000 if you’re married and file separately) regardless of how you used the loan proceeds.

Beginning in 2018, the limits changed and now the maximum amount of mortgage debt is limited to $750,000 if you are married filing jointly ($375,000 if you are married and file separately). Additionally, the loan must be used for building, purchasing, or improving your residence and it can be a primary mortgage, secondary mortgage, line of credit, or a home equity loan. In short: If you refinance or take out a home equity loan, no going out and purchasing a PS5.

However, if your mortgage existed before December 14, 2017, the IRS considers it grandfathered debt. You will receive the same tax treatment as under the old rules.

This is where it can be really helpful to bring in your accountant and make sure you meet the IRS rule that will allow you to take this deduction.

Mortgage interest deduction and refinancing

As stated before, you can deduct mortgage interest after a refinance, but the math starts getting tricky.  Here’s a great statement from TurboTax on how refinances are treated.

“When you refinance a mortgage that was treated as acquisition debt, the balance of the new mortgage is also treated as acquisition debt up to the balance of the old mortgage. The excess over the old mortgage balance not used to buy, build, or substantially improve your home might qualify as home equity debt.

For tax years prior to 2018, interest on up to $100,000 of that excess debt may be deductible under the rules for home equity debt. Also, you can deduct the points you pay to get the new loan over the life of the loan, assuming all of the new loan balance qualifies as acquisition.”

If your head is swimming, don’t worry. So was mine when I first read it.

It’s that last statement you really need to pay attention to when refinancing. Essentially, you may be able to deduct the interest of up to $100,000 of the debt as well as 1/30th of the points each year, assuming it’s a 30-year mortgage.

When you sell or refinance again, you can then deduct all of the discount points not yet deducted—unless you refi with the same lender. In this case, you would add the points on the current loan to the old loan and deduct the points on a prorated basis over the life of the new loan.

If your head is still swimming (and don’t feel bad), work with an accountant to make sure you get this straight.

Related: 13 Books to Take Beginners From Zero to Real Estate Investing Hero

What records do you need to take the mortgage interest tax deduction?

With any tax-related item, you want to keep great records to support your claims. Like Rich Dad Advisor, Tom Wheelright, always says, “If you want to change your tax, you have to change your facts.”

When taking this deduction, it’s no different.  Make sure to keep the following records on hand to document you are entitled to this deduction:

  • Copies of all Form 1098: Mortgage Interest Statements that your lender sends you to document how much mortgage interest you have paid throughout the year. You also want to document any deductible points and mortgage insurance premiums you paid as well.
  • Copies of all HUD closing statements from a purchase or refinance that shows points that you paid (if any).
  • Information about the person who sold you the property if you purchased your home directly or used seller financing. This includes their name, address, and social security number. If you pay interest (and points) to them, you will want to document that as well.
  • Your federal tax returns from 2018 and after so you can track the eligible interest and points you are deducting over the life of the mortgage.

Since you may be deducting mortgage points over the course of 30 years, keep these files on hand for the entire time you have the property.

When shouldn’t you deduct mortgage interest?

Now that you know about the mortgage tax deduction, its rules and limits, how to take it, and what supporting documentation it requires, is there a reason you wouldn’t want to take the deduction?

Maybe.

You see, the 2017 Tax Cuts and Jobs Act nearly doubled the standard deductions for taxpayers, making it unnecessary for many taxpayers to itemize their deductions on Schedule A. In 2020, the standard deduction for an individual is $12,400 on federal income taxes. For a couple married filing jointly, it’s $24,800.

Essentially, for a married couple, they would have to have a combined qualifying deductions of at least $24,800 to make it worth their while to forgo their standard deduction and itemize on Schedule A. Therefore, you wouldn’t want to take the deduction, as you would have a larger tax savings by just using your standard deduction.

However, if you can combine your qualifying mortgage interest deduction with other Schedule A deductions, you could exceed the standard deduction limit and potentially get larger tax savings. These deductions include:

  • State and local taxes taxes
  • Medical and dental expenses
  • Charitable donations
  • Casualty and theft losses
  • All other itemized deductions limited to 2% of AGI
  • Foreign real estate taxes

Tax rules and limits change frequently. A qualified accountant is worth their weight in gold.

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