Last year, I was listening to an interview of six different economists on NPR. The topic was which tax and spending policies were good or bad for America. Two things shocked me: 1) that six economists could agree on anything, and 2) the one thing they agreed on was that the home mortgage interest deduction was a bad policy. They argued that it disproportionately favors the wealthy, encourages excess debt, and drives up the cost of housing. Luckily for us mortgage holders, the only thing Congress thinks is worse than bad policy is not getting re-elected. Therefore, it is highly unlikely that the mortgage interest deduction will ever be repealed, although the amount of mortgage debt that qualifies for the deduction was reduced for home purchases after 12/15/2017.
Today’s article will answer the most common questions about many people’s largest tax benefit, the mortgage interest deduction. One nice thing about the mortgage interest deduction is it is easy to document and unlikely to trigger an IRS audit.
1) Is there a limit to how much mortgage interest I can deduct?
Yes. The first thing to understand is you will only benefit from deducting your mortgage interest if you are itemizing your deductions instead of taking the newly expanded standard deduction. Only 10-15% of taxpayers are expected to itemize based on the new tax laws in 2018 and beyond. That being said…you can still deduct the interest on the first $750k in acquisition debt. This is the total mortgage limit, whether applied to the debt on a single home or two homes. Folks who bought their homes or initiated their mortgages prior to 12/15/2017 are grandfathered under the previous limit and, therefore, can still deduct interest on up to $1 million in mortgage debt.
When you refinance a grandfathered mortgage, the interest is only deductible to the extent that the principal does not exceed the principal balance left on the original loan, unless additional mortgage debt (from a refinance) is used to substantially improve the property.
All these deductibility thresholds are the same whether you are married or single, but they are cut in half if you are married individuals filing separate returns.
2) Does the mortgage interest deduction apply to a vacation home?
Yes! You can deduct the interest on your primary residence and one additional home provided the total acquisition indebtedness does not exceed the thresholds ($750k for properties purchased after 12/15/2017). You would only be able to deduct a portion of your mortgage debt if you exceeded the deductible threshold. For example: If you bought a home (or primary and second home) in 2018 or later and had total acquisition indebtedness of $1.25 million, you could only deduct 60% of the mortgage interest ($750,000 / $1.250,000 = 60%).
3) Can I deduct the mortgage interest if I refinance and increase my loan balance?
Only interest on the remaining acquisition indebtedness balance is deductible unless the increase in loan balance is used to substantially improve the property. Acquisition indebtedness is a loan used to acquire, build, or improve your home.
For example: Suppose you have a remaining $400k balance left on your mortgage. You refinance and borrow a total of $500,000. The interest on the original $400k is deductible. However, the interest on the additional $100k would not be deductible unless the additional funds were themselves used to substantially improve the residence.
4) Can I deduct the mortgage interest on a Home Equity Line of Credit (HELOC)?
Possibly. In general, interest expense from a Home Equity Line of Credit (HELOC) is not deductible (after 2017), unless the loan was used to buy, build, or substantially improve the home that secures the loan (primary residence or second home). In addition, total mortgage interest expense is only deductible on the first $750k in total mortgage debt. HELOC debt used to pay personal expenses (e.g., credit cards, cars, vacations) is no longer deductible.
5) Does interest on rental properties qualify for the mortgage interest deduction?
Yes! Although, this works a bit differently than the home mortgage interest deduction, which is an itemized deduction subject to its own limitations. The interest deduction on a rental property is not limited to $750,000 in mortgage debt, but rather is an expense deductible against rental income. Losses on rental properties (when expenses exceed rental revenue) are only deductible up to a limit (see passive activity rules) and disallowed losses may be carried forward.
6) Does interest paid on an RV or a houseboat loan qualify for the mortgage interest deduction?
Yes! A home is anything that has sleeping accommodations, a toilet, and cooking facilities. This would include mobile homes and even some types of boats. If that isn’t reason enough to buy a houseboat, I don’t know what is.
7) Do I still qualify for the mortgage interest deduction if I rent my home occasionally?
Yes! The mortgage interest is deductible and you don’t even have to claim the rental income if your home is rented for fewer than 15 days a year! One of my clients rents his home out for movie shoots and is always careful to rent it for 15 days or fewer per year. A home rented for fewer than 15 days is classified as a personal use asset (as opposed to a rental property). The qualified mortgage interest and property taxes will be reported as an itemized deduction on Schedule A of your tax return.
On the other hand, if your home is rented for more than 15 days, you must report all your rental income and can deduct your rental expenses. However, you must divide your expenses between the rental use and the personal use. I will leave it up to your CPA or the IRS to “enlighten” you with those details.
Have a great week and email me with questions: [email protected]