Can You Deduct Mortgage Interest? IRS Rules Homeowners Should Know

About this time of year, many homeowners start thinking about April 15th and how mortgage interest deductions affect their taxes. Below are a few reminders based on IRS Publication 936, which explains mortgage interest deductions, equity loans, and second-home rules that homeowners should understand before filing.

Mortgage Interest Deductions

The rule of thumb is that interest from a first mortgage is fully deductible as long as your mortgage balances don’t exceed $750K unless you purchased before December 16, 2017, then $1 million (for married couples). Equity lines are powerful tools for investors wanting to take advantage of opportunities in today’s market. With the limited availability of land loans, this (and seller financing) are often funding sources for vacant parcels. Ads encouraging homeowners to tap the equity in their principal residence always have the caveat that interest “may” be deductible.

Equity Loans, HELOCs, and Cash-Out Refinances

Interest on equity loans, equity lines and cash out refinances is now only deductible under current IRS mortgage interest deduction rules if you use the money to buy, build or improve your home. Interest deductions for monies used to purchase investment properties are treated differently. Don’t forget, equity lines & equity loans are secured as a second mortgage against your home.

Second Homes and Investment Properties

Interest from both your principal and second home mortgage interest can usually be deducted. You don’t have to use the second home during the year as long as it’s not rented. If rented, a certain amount of personal use is required. Be sure to ask your tax advisor or study the IRS publication before assuming interest is deductible.

Points, Wrapped Mortgages, and Prepayment Penalties

Points on a purchase are deductible. Points paid on a refinance are pro-rated over the life of the mortgage. In creative financing, a mortgage might be “wrapped.” In this case the buyer pays the seller and the seller continues to pay their mortgage. Lenders are supposed to be notified when a mortgage is wrapped. Because this is an encumbrance on title, the lender could accelerate (call) the mortgage, so at times, buyers and sellers do not record the agreement. In this case, the interest would not be deductible. Pre-payment penalty payments, common non-conventional mortgages, are usually deductible. Active duty soldiers receive a non-taxable housing allowance, but their mortgage interest is still deductible.

Mortgage Insurance and Special Situations

Mortgage Insurance premiums are almost always required on purchases with less than 20% down. Sadly, the deduction of mortgage insurance is no longer deductible. Certainly, every situation is different so be sure to research Pub 936 and consult your tax advisor. For most of us, our home ownership deduction is likely the closest thing to an economic stimulus we’ll ever see, especially at tax time.

Quick Summary: Mortgage Interest Deductions

• Mortgage interest is deductible up to IRS loan limits
• Equity loan interest is deductible only for home improvements
• Second-home mortgage interest may be deductible
• Investment property interest follows different tax rules
• Mortgage insurance premiums are no longer deductible

Don’t own a home yet? Understanding mortgage interest deductions is one of the many financial benefits of homeownership. If you’re curious about buying a home and how ownership can impact your tax strategy, I’d be happy to help.

This article is for informational purposes only and should not be considered tax advice. Always consult IRS Publication 936 and your tax advisor regarding your specific situation.