What is the mortgage interest deduction? And how does it work?

As you may already know, there are more benefits to having a mortgage than just stability and the ability to build wealth. The IRS also allows homeowners to deduct their mortgage interest, a major incentive in the drive to lower taxable income.

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What is the mortgage interest deduction?

Easy said, the amount of interest you paid on your mortgage last year is the amount of your mortgage interest deduction. For example, if you took out a $300,000 mortgage at a fixed interest rate of 3% three years ago, you likely paid $8,543.28 in interest in 2018 based on your mortgage amortization scale.

Most mortgages let the interest be written off, so that you pay more interest in the first years of your loan and less towards the end of the loan. Don’t worry, you don’t have to calculate the interest amount every year. Your mortgage company will email you IRS Form 1098 if you paid $600 or more in interest, all you need to do is enter the information on the tax forms.

The deduction will help reduce your total adjusted gross income, or the amount you pay tax on. In previous years, you could also deduct what you paid in mortgage insurance premiums, but that deduction expired on December 31, 2017 and is not available for assessment year 2018.

How do you qualify for mortgage interest deduction?

Most homeowners qualify for mortgage interest deductions and can deduct the full amount of interest. The deduction can only be used on mortgages taken out after December 15, 2017 to buy, build or significantly improve a qualified home when the mortgage is appraised at $750,000 ($375,000 if filed separately).

For mortgages taken out before that date, the maximum loan amount is $1 million ($500,000 if married separately). A qualified residence is a primary or secondary residence and does not apply to rental home mortgages or equity lines of credit. If you have an ineligible mortgage that exceeds the limits, you can deduct the qualifying portion of the interest paid. The IRS’ handy flowchart can help you determine if you qualify for the deduction:

How do you claim the mortgage interest deduction?

To request the mortgage interest deduction, enter: the amount of mortgage interest you paid last year as written on your Form 1098, in line 8a of IRS Form 1040. Otherwise, enter it in the appropriate place in your tax preparation software. The trick is that you must specify in order to be able to claim the mortgage interest deduction.

Most people benefit most from taking the standard deduction. but you may want to run the numbers first to see if specifying is a better choice for you. All the work is done upfront to determine the breakdown, and if you choose to itemize and claim the mortgage interest deduction, simply enter the amount in the corresponding field on your tax return.

It can be difficult to decide which software to use to file your taxes online, but in general software programs make specifying a breeze. They do the math for you to compare whether you should itemize or take the standard deduction. Our best software photos are: TurboTax and H&R block. TurboTax is the industry leader and the user-friendly interface guides you through the tax forms using a situational approach and questions.

H&R Block also offers a streamlined approach to file your taxes online and offers the added benefit of being able to get an anticipation loan for a refund should you need it.

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Other tips and tricks

Have you ever heard someone say you shouldn’t pay off your mortgage because it has tax benefits? They usually talk about the mortgage interest deduction. Of course it is advantageous to deduct interest on the mortgage if you are going to pay that interest anyway, but if you are able to pay off your house, don’t let tax deductions stop you.

To remind, a tax deduction lowers your total taxable income, it doesn’t save you from paying that amount in taxes. For example, if you are in the 24% tax bracket because you make $100,000 a year and paid $8,000 in interest on your mortgage last year, the mortgage deduction will only reduce your income to $92,000 and you would still have to pay $16,369.50 in taxes, assuming you had no other deductions or credits. Without the mortgage deduction, you would pay $18,289.50, so the deduction will save you $1,930 to the IRS.

If you hadn’t had the mortgage, you would have saved $8,000 in repayments, so in this case, the mortgage interest deduction isn’t a good reason to hold a mortgage.

Final Thoughts

US homeowners can take advantage of some great tax benefits and you will lose if you qualify for the mortgage interest deduction and don’t claim it. Specifying may seem like an overwhelming task, but if you’re using the best online tax preparation software, it doesn’t have to be.

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