Should I retain my mortgage to claim the mortgage-interest deduction?
Every tax season, I hear many versions of the above question. Clients ask if they should spend more through their business or take on a larger mortgage in order to save on taxes. While you should consider the tax implications of these decisions, you should first consider what is best for your family and broader financial situation.
Recent tax changes have also made the mortgage interest deduction significantly less popular. With the expansion of the standard deduction, fewer taxpayers itemize their deductions. The sum of mortgage interest, charitable contributions, local and state taxes, and other itemized deductions rarely exceed the standard deduction.
In order to determine the tax benefits of retaining a mortgage, you must first calculate how much mortgage interest you could deduct.
Homeowners with older mortgages can generally deduct more interest. If your mortgage was taken out before December 15, 2017, you can deduct interest on up to $1 million in debt for a first and second home. Homeowners with mortgages issued after December 15, 2017, can only deduct interest on up to $750,000 of debt for a first and second home.
For example, pretend you bought a primary home in 2018 with a $500,000 mortgage. In 2021, you bought a second home with a $400,000 mortgage. While you have $900,000 in home debt, you can only deduct interest accrued on $750,000 of that debt.
Your mortgage may have been issued before December 15, 2017, but what if you want to refinance your home? You can still deduct the interest on the refinanced mortgage, up to the $1 million cap, but the refinanced mortgage can generally not exceed the original mortgage.
For example, pretend you were originally issued a mortgage worth $900,000. You have paid your mortgage down to $700,000. If you decide to refinance, you can refinance up to $700,000 of debt and claim the mortgage interest deduction on the entirety of your debt. You could refinance above that amount, to something like $800,000 of debt, as long as you use the additional funds to make improvements on your home. You could then deduct interest on your entire $800,000 mortgage. However, if you use the additional funds for another purpose, you could only deduct interest on $700,000 of your mortgage.
Similarly, you can only deduct interest on home equity loans if the loan is used to “buy, build, or substantially improve” a first or second home. The home equity loan must also be taken out on the home for which it will be used.
Once you have determined how much interest you can deduct, consider your other possible deductions to determine if it makes sense for you to itemize your deductions and claim the mortgage interest deduction. I also encourage you to reach out to the Elm3 tax team for additional assistance.
