If you’re thinking of buying a home this year, a mortgage interest deduction could help you save on your taxes.
The Internal Revenue Service (IRS) offers some very attractive tax deductions for homeowners with a mortgage. This is especially valuable in the first few years of homeownership, when the amount paid in interest can seem high compared with what you pay toward principal.
To take full advantage of your mortgage’s tax advantages, there are four things you need to know about your mortgage and the IRS.
How to qualify for a mortgage interest tax deduction.
Eligibility for a mortgage interest tax deduction requires that your mortgage helps you buy, improve or build your residence. Up to two homes can qualify, but you must use both homes for personal purposes.1 In other words, investment properties do not qualify for mortgage deductions. If you rent one of your homes to tenants during the year, you can’t deduct under this rule. To qualify, you have to live in a residence either for 15 days or more per year, or for more than 10 percent of the time you rent it out, whichever is longer.
Limits for your deduction
Whether you have one or two properties, you can deduct only the interest accrued on the first $1 million of your mortgage loans. So, even if you have two mortgages that are each under $1,000,000—say your primary residence has an outstanding mortgage of $450,000 and your vacation home has a $650,000 mortgage—you won’t be able to deduct all of the interest. For married couples filing separately, each individual’s ability to deduct interest is capped at $500,000 in mortgage loans. The only exception to this rule is if you took out a mortgage before Oct. 13, 1987, in which case all of the interest can be deducted, no matter the amount.
Mortgage points are eligible
To get a lower interest rate, you may choose to pay mortgage points, otherwise known as prepaid interest, upon purchase. Points are often tax deductible in the year they were paid, provided you haven’t reached your limits for the mortgage interest deduction. For example, if you paid $6,000 in points to lower your interest rate, you can add that $6,000 to your total mortgage interest deduction for the year you buy your home.2
Home equity loans and lines of credit are eligible
If you just bought your home, this might not yet affect you, but it’s worth knowing: Interest on any loan where your home is used as collateral qualifies, meaning you can deduct interest paid on home equity loans and lines of credit. Practically speaking, that means that if you take out a loan on your home to make home improvements, that interest is deductible.
There’s so much more to learn about buying a home on usbank.com. Continue reading and ask yourself these questions before buying.