6.3 Mortgage interest and points

Mortgage interest and points can significantly impact your tax bill. Understanding the rules for deductibility is crucial for homeowners looking to maximize their itemized deductions. The Tax Cuts and Jobs Act brought major changes to these deductions, affecting both new and existing mortgages.

Knowing the difference between acquisition and home equity debt is key. While interest on acquisition debt remains deductible within limits, home equity debt interest is now only deductible if used for home improvements. Points paid on mortgages have their own set of rules, often requiring amortization over the loan's life.

Mortgage Interest Deductions

Deductibility Criteria and Qualified Residences

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• Mortgage interest deductible for taxpayers itemizing deductions on Schedule A of Form 1040
• Applies to interest paid on mortgages for qualified residences
  • Primary residence
  • One additional home used as personal residence
• Mortgage must be secured by qualified residence for interest deduction eligibility
• Deduction limits based on loan origination date
  • Loans after December 15, 2017 deduct interest on up to $750,000 of qualified residence loans ($375,000 if married filing separately)
  • Loans before December 16, 2017 deduct interest on up to $1 million of qualified residence loans ($500,000 if married filing separately)

Home Equity Loan Interest Deductibility

• Interest paid on home equity loans or lines of credit deductible only if loan used to buy, build, or substantially improve taxpayer's home securing the loan
• Examples of deductible uses
  • Adding a new room to the house
  • Renovating the kitchen or bathroom
  • Installing a new roof or HVAC system
• Examples of non-deductible uses
  • Paying off credit card debt
  • Financing a vacation
  • Purchasing a car

Acquisition vs Home Equity Debt

Definitions and Characterization

• Acquisition indebtedness involves mortgage debt incurred to buy, build, or substantially improve a qualified residence
• Home equity indebtedness encompasses any debt secured by qualified residence not classified as acquisition indebtedness
• Characterization as acquisition or home equity debt affects interest deductibility and application of deduction limits
• Refinancing of acquisition indebtedness retains its character up to the amount of old mortgage principal just before refinancing

Tax Treatment Changes

• Pre-Tax Cuts and Jobs Act (TCJA) interest on both debt types generally deductible, subject to certain limits
• Post-TCJA only interest on acquisition indebtedness deductible
• Home equity indebtedness interest no longer deductible unless funds used for home improvements
• Examples of acquisition indebtedness
  • Mortgage to purchase a new home
  • Loan to build an addition to existing home
• Examples of home equity indebtedness (potentially non-deductible post-TCJA)
  • Home equity line of credit used for debt consolidation
  • Second mortgage used to finance a child's education

Deductible Mortgage Points

Deductibility Criteria and Calculation

• Points represent prepaid interest charges (loan origination fees, maximum loan charges, premium charges)
• Points paid on loan to purchase or improve primary home generally fully deductible in year paid if meeting IRS criteria
• Points not fully deductible in year paid must be amortized over loan life
• Calculate deductible portion of points in given year
  • Divide total points paid by number of payments over loan life
• Deduction for points subject to same limitations as mortgage interest under TCJA

Special Considerations for Different Loan Types

• Points paid on refinancing loans generally not fully deductible in year paid
  • Must be amortized over loan life
• If portion of refinanced funds used for home improvements, that portion of points may be deductible in year paid
• Examples of point deductibility
  • $3,000 in points paid on 30-year mortgage for primary home purchase fully deductible in year paid
  • $2,000 in points paid on refinancing existing mortgage amortized over 180 months (15-year loan term)

Mortgage Interest Limitations

Tax Cuts and Jobs Act (TCJA) Changes

• TCJA reduced mortgage debt limit for interest deductibility
  • From $1 million to$750,000 for loans originated after December 15, 2017
• $750,000 limit applies to combined amount of loans used to buy, build, or substantially improve taxpayer's main home and second home
• Married couples filing separately debt limit $375,000 each for post-TCJA loans
• TCJA eliminated deduction for interest on home equity indebtedness unless loan proceeds used to buy, build, or substantially improve taxpayer's home securing loan

Implementation and Future Considerations

• TCJA limitations set to expire after 2025, reverting to pre-TCJA rules unless Congress takes further action
• Taxpayers must carefully track loan proceed use to determine deductibility under new rules
• Increased importance of maintaining accurate records of home improvement expenses to justify interest deductibility on home equity loans
• Examples of tracking loan proceed use
  • Keeping receipts for materials and labor for home renovation projects
  • Documenting timeline of improvements coinciding with loan disbursements