The tax laws encourage home ownership with a variety of tax breaks, and the largest involves deducting the interest that homeowners pay on mortgages. Right now, there aren't major legal changes on the books that will affect the mortgage deduction in 2017, but the recent results of the presidential election point to a broader shift that could have implications for some homeowners in the future. Let's look more closely at how the mortgage interest deduction works and how it interacts with other home-related tax breaks.
What is the mortgage interest deduction?
Homeowners can typically take the mortgage interest they pay for loans on their home and include it in their itemized deductions. There are two separate provisions that apply to most homeowners. For what's known as home acquisition debt, the limit on deductible interest is whatever a mortgage of $1 million costs. Home acquisition debt includes what you borrow in order to buy, build, or substantially improve either your main residence or a second home. You can also refinance such a mortgage and still have it treated as home acquisition debt. Multiple mortgages can be deductible, as long as the principal balance doesn't exceed the $1 million limit, or $500,000 for married taxpayers who file separately.
In addition, interest on home equity debt can also be deductible. Home equity debt essentially includes any other loan that is secured by your main home or second home. A lower borrowing limit of $100,000 for most taxpayers or half that for married taxpayers filing separately applies to home equity debt.
What counts as mortgage interest?
The portion of your monthly payment that goes to interest clearly counts as deductible mortgage interest for these purposes. However, there are a couple of special cases that need further explanation.
First, if you pay upfront points when you get your mortgage, the way you can deduct them varies. In some cases, as long as you use the loan to buy or build your main home and the amount of points paid is consistent with industry practice in your area, then you might be able to deduct your points as interest in the year you pay them. That typically includes the first mortgage you take out when buying a home. By contrast, refinancing and borrowing for other purposes don't qualify for immediate deduction of points, but you can still amortize the deduction over the course of the loan.
Next, the question of whether private mortgage insurance payments are deductible is still an open question for 2017. Late last year, lawmakers extended the annually renewing provision through the end of 2016. However, it hasn't considered whether to extend beyond the end of this year, and so taxpayers will have to wait to see if a last-minute set of tax extenders includes the provision.
Will President Trump change the mortgage interest deduction?
One big question mark involves what the newly elected president will do with anticipated tax reform efforts. Few expect any new tax plan to include specific provisions eliminating the mortgage interest deduction, and Congress has repeatedly steered clear of hitting mortgage interest in its looks at various tax deductions more broadly.
One Trump proposal during the campaign did impose a limit on itemized deductions at $100,000 for single filers and $200,000 for joint filers. It's conceivable that for some high-net-worth individuals, such a cap might reduce total itemized deductions, and some would see that as a limit on mortgage interest deductions. However, given the existing $1 million and $100,000 caps and since interest rates are so low, mortgage interest would rarely make up a substantial portion of total deductions exceeding the $100,000 or $200,000 thresholds.
If you own a home, you're probably aware of the tax ramifications of your purchase, and deducting mortgage interest can be a big part of what makes your home affordable. Fortunately, homeowners shouldn't expect anything that hurts their ability to cut their taxes through claiming a mortgage interest deduction.