While home ownership in the U.S. is at historic lows (only 63.5% in the third quarter of 2016), there are still millions of individuals who own their own homes. Well, they don’t necessarily own them outright; about 70% of homeowners continue to pay off a mortgage used to swing the purchase, refinance a prior loan, or tap into equity. Repayment of principal is never deductible, but interest can be deductible by those who itemize. Here are five things to know about deducting the interest on this debt.
1. Two-residence limit applies
You can deduct interest on a mortgage on your principal residence and one other residence (e.g., a vacation home). You don’t have to live in the second residence to designate it as a qualified home for mortgage interest purposes. However, if you rent it out for part of the year, you must use it as your home for more than 14 days or 10% of the days rented, whichever is greater.
If you own more than two residences, it’s up to you to designate the home for which interest will be deducted. This designation can apply to a boat, recreational vehicle, or house trailer as long as it has sleeping, cooking, and toilet facilities.
If you use part of your home as a home office, a portion of the interest won’t be deducted as a personal expense. It will become part of the home office deduction.
2. Dollar limits apply
Dollar limits apply to loans taken out after October 13, 1987. Interest on such loans is deductible in full only for loans up to:
Married persons filing separately must cut in half the limits on indebtedness. Co-owners who are not married to each other can each use the full limits.
3. Points are deductible
Points are a form of prepaid interest that usually is deducted over the term of the loan. Thus, if you refinanced your initial mortgage in 2016, you must prorate the deduction over the term of the new mortgage. However, if you bought a main home, points paid to obtain the mortgage may be fully deductible.
If you refinanced a mortgage that was previously refinanced and you had to pay points on the prior or on the current mortgage, you are eligible for a deduction, provided the new refinancing was with a different lender. You can deduct the balance of the points on the old mortgage that had not previously been deducted, plus the portion of points on the new mortgage that is allocable to the year.
4. Mortgage insurance
Mortgage insurance paid to obtain a loan when putting less than 20% down usually isn’t deductible. However, the premiums on mortgage insurance obtained to buy a home in 2016 may be deductible as mortgage interest. Income caps apply to the homeowner, which may limit or prevent a deduction. This tax break expired at the end of 2016 and, at this time, it is unclear whether it will be extended for 2017.
5. High income taxpayers
After figuring your deductible mortgage interest, there may be one more step to determining the amount deductible. High-income taxpayers can lose up to 80% of their mortgage interest deduction. For 2016 returns, high-income taxpayers are those with adjusted gross income over:
There has been considerable talk about coming tax reform. Whether it will change the rules for home mortgage interest remains to be seen.