There are elements of your mortgage payment that are tax deductible, namely your mortgage interest and property taxes. Under certain circumstances you may be able to deduct other expenses, but your principal payments on your mortgage are never deductible. Before you file your taxes, make sure you've left no deduction unturned, but don't make the mistake of giving yourself tax breaks that aren't allowed.
Mortgage Interest Deductions
The home mortgage interest deduction is the biggest break most taxpayers get. Don't misunderstand how it works, because a deduction is not the same as a credit. Tax credits effectively reduce taxes by the entire amount of the credit. For example, in 2009 new home buyers received a credit of $8,000, which reduced their total tax due by $8,000. By contrast, if you paid $8,000 in mortgage interest for the year, it would not reduce your taxes by that amount. Your taxable income is reduced instead. So if you pay $8,000 in interest and are in the 25 percent tax bracket, your mortgage interest deduction actually reduces your taxes by $2,000, or 25 percent of $8,000. The higher your tax rate, the more the deduction winds up saving you. You will itemize tax deductions using Schedule A with Form 1040.
Interest Deduction Fine Print
Your interest deduction is limited to your first $1 million in debt, or $500,000 if you're married filing separately. If your mortgage is for more than a million dollars, you may still deduct interest on the first million in loans, but not on any amount above that. If you have a home equity loan or home equity line of credit, you may only deduct interest on a loan of up to $100,000. The home equity loan can be in addition to your primary mortgage, so you can deduct interest on up to $1,100,000 in loans. Second homes, like vacation property, qualify for the deduction as well but are included under the million dollar cap. If you pay points to reduce your interest rate when you take out a mortgage, you may deduct them all at once for a new home purchase. If you refinance a mortgage, you can still deduct the points but you must do so over the life of the loan.
Your monthly mortgage payments may include payments for Private Mortgage Insurance (PMI), real estate taxes and homeowners insurance, in addition to your principal payments. PMI is tax deductible if the insurance contract was issued after 2006, but the amount of the deduction may be reduced or eliminated if your adjusted gross income exceeds $100,000, or $50,000 if you are married but filing separately. Real property taxes paid to your local government are deductible whether you pay them together with your mortgage or you pay them directly. If you take a standard deduction and don't itemize, you may still take a deduction of $1,000, or $500 for single filers, by submitting a Schedule L with your tax return. Homeowner's insurance is not deductible unless it is a rental property.
When you're dealing with a rental property that you own, many of the rules change. Principal payments are still not tax deductible, but you can deduct most other expenses. Mortgage interest, homeowners insurance, and real estate taxes are all deductible and offset any rental income. Landlords must file a Form 1040 Schedule E, which details all expenses plus rent intake. If you pay property taxes and insurance together with your mortgage, you must itemize the totals for each item separately on Schedule E.
- IRS: Expanded Tax Breaks Available for 2009 First-Time Homebuyers
- IRS: Publication 936
- Iowa State Univ. Center for Agricultural Law & Taxation: IRS Again Clarifies Its Position on Home Mortgage Interest Deduction Limitation
- Kiplinger: The Most Overlooked Tax Deductions
- Bankrate.com: Home Equity Loan Interest Is Deductible – to a Point
- IRS: Additional Standard Deduction for Real Estate Taxes
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