Mortgage Tax Deductions: What Is Tax Deductible?

Just like clockwork whether we want it or not it’s getting close to tax time. The IRS began accepting and processing federal income tax returns late last January. For the “EZ-Filers” it’s very likely many have already submitted their electronic returns and are anxiously awaiting their refunds. The EZ form is for those who don’t itemize deductions on their returns and who regularly get a refund each and every year. Others who do itemize their deductions are now gathering their records, receipts and documentation needed in order to prepare a federal and state income tax return. Perhaps one of the more common of deductions is related to a mortgage loan.

What is tax deductible on your mortgage?

mortgage tax deductions interest

Mortgages and Tax Deductions

Owning a home and as well as a mortgage is one of our most cherished of “American Dreams” and in addition to owning a piece of real estate instead of just occupying it and paying a landlord each month there are some definite income tax advantages owning real estate. You can visit our rent vs. buy calculator here and run your own numbers as well as seeing a graphic display of the power of owning vs. renting here in San Diego County. The math almost always works out not just in terms of monthly payments but also the tax advantages a mortgage payment has compared to rent.

When you pay rent all you get is a roof over your head. There are no income tax deductions for rental payments made to a landlord or a property management company. Instead, the advantages are reserved for your landlord, not you. Your landlord figured long ago the unit you occupy is completely paid for each month by a tenant. Not only does the rent take care of the mortgage payment but also the property taxes, insurance and maintenance. Not bad. That is if you’re the landlord.

Yes, renting does have its own advantages but when you’re considering buying a home and no longer pay rent money it’s important to understand your income tax bite each year will be smaller when you finance a home. Before we get too much further however it’s important to understand the difference between a deduction and a credit. A deduction is an amount subtracted from your adjusted gross income. Once all your deductions are subtracted your tax bracket is based upon the final amount, not the amount before your deductions. A tax credit is an amount given to you.

Well, maybe not given because you have to pay taxes in the first place but is an amount that is subtracted from the taxes you owe.

Mortgage Tax Deductions : Interest

The most common tax deduction is reserved for mortgage interest on your loan. When you make a payment each month to the mortgage company you’re actually making two payments- one to pay down the loan balance, or principal, and the other to the mortgage company in the form of interest. Let’s take a look at a $400,000 loan at 4.25% over thirty years. The monthly principal and interest payment is about$1,967 per month. Over the first year alone, the amount of interest paid to the mortgage company adds up to $19,865. That’s an income tax deduction and the biggest
one you’ll get.

Let’s say that your adjusted gross income is $90,000. In this example, you’ll get to subtract $19,865 in interest lowering your adjusted income and therefore lowering the amount of tax you’ll have to pay. Instead of paying taxes on $90,000 your tax bill will be based upon $70,135, or nearly $20,000 less in taxable income. If your rent payment were also $2,000 per month your taxable income would still be $90,000.

Property Taxes

You own real property which means you owe real property taxes. The property taxes you pay each year assessed on your home are eligible for a tax deduction. Again, this is an amount deducted from your adjusted taxable income. If your home is valued at $400,000 and your property tax bill is 1% of that amount, or $4,000. Property values can be protested if you think your home was appraised too high which can result in a lower amount yet such protests are relatively unsuccessful.

Discount Points

Did you pay discount points to lower your rate when you bought your home last year? A discount point is expressed as a percentage of your initial loan amount. If on a 30 year mortgage, one point, or one percent on a $400,000 loan can lower your rate by about 0.25%. The point is $4,000 in this example and deductible in the year paid.

If you paid points during a refinance transaction, the point can be deducted but only over the life of the loan. If you refinanced into a new 30 year loan and your discount point was $4,000 the annual deduction is $4,000 divided by 30, or $133.33 per year.

Prepaid Interest

When you take out a new home loan you will also pay prepaid interest to the new lender based upon a per diem amount leading up to the first of the following month. For example, if you close on the 20th your new lender will collect 10 days of interest which in effect is your first mortgage payment. Because this is in fact mortgage interest, it is also tax deductible but one that is often missed.

mortgage tax deductions rental property

Rental Property Deductions

When you own rental property, in addition to the items listed here, you may also deduct expenses when you advertise for a new tenant, maintenance, commissions to real estate agents to manage and show your property and expenses incurred traveling to the rental property for an inspection or business related purposes. Rental real estate is also considered a depreciable asset and you can deduct this depreciation from your rental income as well.

Finally, it’s critically important you work with your accountant or financial planner when preparing your income tax returns. Real estate deductions can get a bit complicated especially when you begin to own investment properties so make sure you speak with a licensed professional who can help.

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I hope you enjoyed reading this article. It's my goal to keep you updated with the latest real estate mortgage news. I'm proud to provide you with 100% original and unique content. Subscribe now to get high quality real estate mortgage content and articles delivered directly to your inbox. Chad Baker is Regional Manager for LendUS. Chad is consistently recognized in the top 1% of mortgage originators in the United States 2011-2017. Got a question for Chad? Call (858) 353-8331 or submit your question online