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Mortgage interest tax deduction: How it works and when it makes sense

Yahoo Personal Finance· Getty Images
Updated 4 min read

When you file your income tax returns each year, the mortgage interest deduction (MID) can be one of the most valuable benefits of owning a home. Or it can be worthless.

That contradiction exists because the value of the MID depends on whether your itemized deductions exceed the standard deduction, and that depends on how much mortgage interest you paid during the year, your other deductions, and your standard deduction for your filing status and the tax year.

Sounds complicated? Well, it is.

Dig deeper: Standard deduction vs. itemized deduction: Which is best for you?

Mortgage interest is generally tax deductible. However, you should be aware of some important rules, limits, and exclusions before you claim this deduction on your tax returns.

The federal Tax Cuts and Jobs Act of 2017 (TCJA) limited the MID to interest paid for the first $750,000 of mortgage debt for mortgages originated after Dec. 15, 2017. Previously, the limit was $1 million of mortgage debt. For married couples filing separately, those limits are cut in half.

The TCJA continued to allow mortgage interest for both a primary residence and a second home to be deducted, but the new law excluded interest paid for home equity loans unless the funds were used to build, buy, or make substantial improvements to the home that secures the loan. Previously, interest paid for up to $100,000 of home equity debt could be deducted regardless of how the funds were used.

Read more: HELOC vs. home equity loan: Which is better for you?

The previous rules are still important because the TCJA is scheduled to sunset at the end of 2025. After that, the previous rules will again be in effect, unless Congress extends the TCJA MID provisions or makes other changes to the MID.

To claim the MID, you'll have to itemize your deductions on your tax returns. Itemizing can be complicated and generally makes sense only if your deductions exceed your standard deduction, which is available if you choose not to itemize.

The TCJA increased the standard deduction for most taxpayers to $12,000 for individuals, $24,000 for joint tax filers, and $18,000 for heads of household for 2018. Those amounts are "indexed" (i.e., adjusted) for inflation, so they can and typically do change from year to year.

Previously, the standard deduction for most taxpayers was $6,500 for individuals, $13,000 for joint filers, and $9,550 for heads of household.

The higher amounts will be in effect until the TCJA sunsets at the end of 2025 unless Congress extends the standard deduction provisions of the law or makes other changes to the standard deduction. Since the standard deduction is indexed for inflation, it's impossible to predict in advance what the amounts will be for 2026 or subsequent years.

Tip: If you itemize your deductions, you may be able to deduct some or all of your property tax as well as your mortgage interest on your tax returns. The property tax deduction could help you boost your itemized deductions to exceed your standard deduction and make itemizing worth the effort.

There's also another reason the value of your MID may vary from year to year: With a typical fixed-rate mortgage, the interest portion of your monthly mortgage payment — the part that may be tax-deductible — gets smaller as a portion of your payment over time. A smaller deduction may diminish your tax savings.

The MID is part of the federal tax code. State tax codes typically also allow this deduction.

Special rules may apply if you rent out your home for part of the year or use part of your home as a home office for business purposes.

Read more: Here are 7 free tax filing options

As a general rule, the more income you earn and the bigger your mortgage is, the more valuable the MID may be for you if you itemize your deductions and your itemized deductions exceed the standard deduction for your filing status for a given tax year.

That said, the MID shouldn't be a reason to get a bigger mortgage — or any mortgage — if you can't afford the monthly payment or you're not financially comfortable with the payment, the other costs of owning a home, and all your other expenses.

If you are going to buy a home and itemizing your deductions makes sense for you, the MID could be a nice tax-saving opportunity to take advantage of.