Homeownership is an opportunity for a buyer to put down roots and begin paying toward an asset they’ll likely hold for years to come. When comparing buying a home to renting, some homebuyers may consider the tax benefits of buying, including the often-touted mortgage interest deduction.
The Tax Cuts and Jobs Act (TCJA) of 2017 decreased how much interest homeowners can deduct on their mortgage from a debt balance of $1 million to $750,000 and increased the standard deduction. So homeowners after 2017 will need to do the math and decide if it makes more financial sense to take the larger standard deduction or itemize and leverage the mortgage interest deduction.
Here’s how the mortgage interest deduction works for homeowners and other deductions to explore if a mortgage exceeds the cap.
What is the Mortgage Interest Deduction?
The mortgage interest deduction is a tax deduction available to homeowners to help offset the expense of owning a home. A homeowner can generally take the deduction on a primary residence and a secondary residence as long as both mortgages meet the requirements outlined by the IRS.
For 2022, taxpayers can deduct interest on a mortgage up to $750,000 if single or married filing jointly. Those who are married filing separately face a limit of $375,000 per filer. The IRS changed the deduction limit as of December 15, 2017. Any mortgages taken out before that time are eligible to deduct interest on up to $1,000,000.
Here’s what this could look like for an average homeowner. For example, say a married couple bought a home in 2021 with a mortgage of $600,000. With an interest rate of 5%, they’d be paying an estimated $30,000 in mortgage interest for the tax year 2022. The standard deduction for 2022 for those married filing jointly is $25,900. That means by itemizing deductions and taking the mortgage interest deduction alone, the homeowners will have a lower taxable income (since they can subtract $30,000 instead of $25,900).
What Happens if a Mortgage is Larger Than the Deduction Cap?
If someone buys a home after 2017 and has a mortgage greater than $750,000, they can deduct interest paid on the first $750,000 of the mortgage. However, any mortgage interest paid past $750,000 will not be deductible and won’t help lower taxable income.
Other Tax Deductions for Homeowners
Other tax deductions available to homeowners can help offset the limits of the deduction cap. Homeowner specific tax deductions include:
- Property taxes: Homeowners who are married filing jointly can deduct up to $10,000 in property taxes. For single filers or married filing separately, there’s an opportunity to deduct $5,000. Depending on where someone lives, property taxes could be a significant expense of homeownership.
- Mortgage points: One way to reduce the interest rate on a mortgage is by purchasing mortgage points up front. Typically, to lower the interest rate by .25%, the borrower needs to buy one point for 1% of the loan cost. Like the mortgage interest deduction, a homeowner can deduct mortgage points for the first $750,000 of the mortgage.
The Bottom Line
The mortgage interest deduction is a valuable money-saving tool for homeowners who itemize their taxes. But it’s important to be aware of the mortgage interest deduction cap and what it means for homeowners facing a significant mortgage on a new home.