The home mortgage interest deduction is one of the most popular tax benefits in the United States, highly valued by realtors, homeowners, potential homeowners, and accountants alike. However, the perceived value of this benefit sometimes overshadows the actual benefit it provides.
Homeowners who itemize their taxes can deduct mortgage interest on loans up to $750,000. This cap was lowered from $1,000,000 to $750,000 as a result of the Tax Cuts and Jobs Act of 2017 (TCJA). This legislative change, coupled with the TCJA's significant increase in the standard deduction—roughly tripling it—means that fewer taxpayers find it beneficial to itemize deductions.
Consequently, for many homeowners, the mortgage interest deduction has lost its previous tax return value because the increased standard deduction exceeds the sum of their itemized deductions, including mortgage interest. This shift has made the deduction less impactful for a substantial number of taxpayers.
Allowance for Mortgage Interest Present
Before the implementation of the Tax Cuts and Jobs Act of 2017 (TCJA), the tax landscape was quite different. The TCJA made significant changes starting in 2018, including reducing the cap on deductible mortgage interest from $1 million to $750,000. It also substantially increased the standard deduction—effectively quadrupling it—while eliminating personal exemptions. These changes made itemizing deductions less beneficial for many taxpayers, as the increased standard deduction often offered greater tax savings than itemizing.
It is estimated that in the first year of the TCJA's enactment, 135.2 million taxpayers will choose the standard deduction. In contrast, only about 20.4 percent of taxpayers are expected to itemize their deductions. Among those itemizing, approximately 16.46 percent will claim the mortgage interest deduction.
The common misconceptions surrounding this issue include the belief that all homeowners receive a tax deduction for mortgage interest and that this deduction directly reduces their taxable income. However, the reality is that the benefit of the mortgage interest deduction depends on whether it is more advantageous than the standard deduction, which now applies to a larger portion of taxpayers.
You'll be eligible for a tax break.
The vast majority of homeowners do not benefit in any way from the mortgage interest tax deduction, despite widespread belief otherwise. Homeowners who do not itemize their deductions when calculating their taxable income will not be eligible for this deduction. Mortgage interest, property taxes, and some medical expenses can all be considered by itemizing. The ability to deduct mortgage interest is commonly highlighted as a financial inducement to buy a home because it is typically the largest of these expenses a taxpayer spends.
As before, itemizing deductions may seem appealing in theory, but once the TCJA was passed, it became clear that doing so was not in anyone's best interest.
The standard deduction for individuals and couples filing separately in 2022 is $12,950 and will increase to $13,850 in 2023. In 2022, a household head may expect to bring in $19,400 (this rises to $20,800 in the following year). The standard deduction for a married couple filing jointly will be $25,900 in 2022 and $27,700 in 2023.
Mortgage interest payments provide no tax benefit to taxpayers who do not itemize deductions because their total deductions do not exceed the standard deduction thresholds.
Misunderstandings Are That The Deduction
The second of the five common misunderstandings is that the deduction will be pretty significant. Those fortunate enough to be able to deduct their mortgage interest payments from their taxable income may find that their deduction is only a tiny portion of their actual interest costs. The deduction is not a tax credit, so some calculation is necessary to understand the situation.
You don't get a dollar's worth of tax savings for every dollar spent, but you get a little fraction of one. The mortgage interest deduction lessens taxable income by a percentage equal to the taxpayer's marginal tax rate, while a credit decreases taxes owing by the same amount.
To use a simplified example, a taxpayer who pays an individual income tax rate of 24% and has mortgage interest expenses totaling $12,000 would be able to subtract $12,000 from income tax liability, resulting in a savings of $2,880. This means that the homeowner forked over $12,000 in interest to the bank in exchange for a tax break of less than $2,000.
One Way That Works Better
Even if the couple does not have a mortgage, they will still be eligible to take advantage of the standard deduction and its associated tax benefits. Instead of saving $3,336 thanks to your tax deduction for paying $12,000 in real money to the bank in mortgage interest, you'd be out that much. It's not worth the hassle of itemizing deductions to claim the mortgage interest tax break; the standard deduction is much larger.
No one, not even those in higher tax brackets, would save money unless they also itemized numerous other large deductions. At the 35% individual tax rate, a person who pays $12,000 in mortgage interest can deduct only $4,200. That's not quite as much as the taxpayer would get if they claimed the standard deduction instead. In the table below, we can see the "advantage" of the mortgage interest deduction.
