Although the home mortgage interest deduction is one of the most oft-cited benefits of owning a home, most taxpayers don’t take advantage of it because it requires itemizing taxes. If itemized deductions including mortgage interest paid throughout the year exceed the standard deduction, a taxpayer can take advantage of the benefit.
The benefit isn’t as great as it sounds. If you pay interest, it certainly does help to get a tax benefit, but it rarely tips the balance of the long-term financial effects of renting vs. buying a house. Don’t let the real estate industry sway your opinion about owning a house through this faulty rationale. And certainly don’t decide to take out a mortgage if you were intending to buy with cash. Since this is a deduction, your taxes are reduced by only a percentage of the interest you pay, related to your tax bracket.
The home mortgage interest deduction is currently endangered. The Obama administration and Congress are looking for ways to cut spending, and this tax deduction is on the table for consideration. Some estimated put the cost of this deduction at $100 billion each year.
Despite the cost and its overstated effects, the tax deduction has helped convince renters to become homeowners — at least among people I have spoken with. In other words, for the cost of $100 billion, the economy has seen the benefit of a growing real estate market for many years. This law has made the National Association of Realtors, a lobbying group for the real estate industry, very happy, and they are working hard to prevent the government from eliminating the tax deduction.
There are many rules that determine whether you can claim the interest you pay on your mortgage for a tax deduction. The rules help ensure that the benefit goes to home owners rather than “investors” who earn a living from flipping houses, though due to market conditions the past few years, that activity has been less of an issue.
The interest you pay for construction, purchasing or improving your primary or secondary home, whether through a mortgage, home equity loan, or home equity line of credit, qualifies. There are limitations, though. You can deduct interest paid on up to only $1,000,000 of home acquisition debt. For home equity debt, which is any loan that was taken not to construct, purchase, or improve a house, you can deduct interest paid on up to only $500,000 of this debt or the fair market value of the home, whichever is less. For taxpayers who are married, filing separately, each of these limits is reduced by half.
Normally, the total of all of your itemized deductions are limited by income, but that income limitation was lifted in 2010. It could be lifted again if the benefit is not eliminated.
Question for homeowners: Do you take the home mortgage interest deduction? Question for everyone: Should this deduction be eliminated for the sake of reducing the national budget deficit?
Published or updated January 12, 2012.