How to Calculate Mortgage Interest Deduction for Your Tax Return

Understanding how to calculate the mortgage interest deduction can significantly impact your tax return and reduce your taxable income. This deduction allows homeowners to subtract interest paid on a qualified home loan, offering substantial savings for those who itemize deductions instead of taking the standard deduction.

This article explores the key aspects of determining eligibility and calculation methods for this valuable tax benefit.

Qualified Loans

To qualify for the mortgage interest deduction, the loan must be secured by a qualified residence, which includes your primary and secondary homes, as well as certain refinance loans.

Primary Home

The primary home is where you primarily reside, and it must be used as collateral for the mortgage to qualify for the deduction. Under the Internal Revenue Code Section 163(h), interest on a mortgage for your principal residence can be deducted up to specific limits based on when the debt was incurred. For mortgages taken out after December 15, 2017, the deduction is limited to interest on the first $750,000 of loan debt ($375,000 if married filing separately). For loans predating this cut-off, the limit is $1 million ($500,000 if married filing separately). Documentation is essential to confirm the residence as your primary home.

Secondary Home

A secondary home, such as a vacation property, can also qualify for the mortgage interest deduction if it is used primarily for personal purposes rather than rental. The IRS allows you to designate which property is your secondary home if you own multiple properties, but the home must be used personally for more than 14 days a year or more than 10% of the total days rented, whichever is greater. The same deduction limits apply as for primary residences. If the home is rented out, the personal use days will determine eligibility for the deduction.

Refinance Loans

Refinancing can impact the mortgage interest deduction, particularly if the new loan exceeds the remaining balance of the original mortgage. According to IRS guidelines, interest on the amount that exceeds the old mortgage balance is deductible only if the additional funds are used to substantially improve the qualified residence. The $750,000/$1 million thresholds also apply to refinanced loans, but the date of the original mortgage determines the applicable limit. Maintaining detailed records of how excess funds are used is critical to ensure they qualify as deductible.

Deductible Points

Deductible points, also known as loan origination fees or discount points, are prepaid interest paid at closing to reduce the mortgage interest rate. The IRS allows these points to be deducted in the year they are paid if specific conditions are met, such as the loan being secured by your primary residence and the points being a customary amount for the area.

To qualify, points must be calculated as a percentage of the loan principal. For example, if you take out a $200,000 mortgage and pay $4,000 in points, this equals 2% of the loan amount. Points paid on a refinance loan, however, must generally be amortized over the life of the loan. For instance, if you refinance a 30-year mortgage, the deduction for points is spread out over 30 years.

Calculating the Deduction

To calculate your mortgage interest deduction, gather all relevant documentation, including Form 1098 from your lender, which details the total interest paid on your mortgage during the year. Confirm that the interest reported aligns with your records. Determine the portion of interest that qualifies for deduction, considering loan amounts and tax regulation limits.

For example, under the Tax Cuts and Jobs Act of 2017, if your mortgage exceeds the $750,000 threshold, only the interest on the first $750,000 is deductible. If your mortgage is $900,000, only the interest on $750,000 qualifies.

Itemizing on Tax Returns

Itemizing deductions involves weighing the benefits of itemizing individual expenses, like mortgage interest, against the simplicity of taking the standard deduction. Homeowners often find that the mortgage interest deduction constitutes a significant portion of their itemized deductions. For 2023, the standard deduction is $13,850 for single filers and $27,700 for married couples filing jointly. If your total deductible expenses exceed these thresholds, itemizing may be more advantageous.

Review all deductible expenses to ensure they meet IRS guidelines. For homeowners, mortgage interest often combines with state and local taxes (SALT)—capped at $10,000—and other deductions to surpass the standard deduction. Keeping accurate records of expenses simplifies the itemizing process and ensures accurate tax returns.

Documenting Interest Paid

Accurate documentation of mortgage interest paid is essential to substantiate your deduction claim. Form 1098, provided by your lender, is the primary document outlining total interest paid during the year. Cross-verify this information with your own records, such as monthly mortgage statements and bank transaction histories.

If you’ve refinanced, ensure that any points paid are appropriately amortized over the loan’s life. Also, keep records of any changes to your mortgage, such as refinancing or loan modifications, as these can affect your deduction. Proper organization of these documents simplifies tax preparation and ensures you maximize eligible deductions.