If you have a mortgage, you’ll probably receive an IRS Form 1098 in the mail. Your mortgage lender is required to use this form if you paid more than $600 in mortgage interest last year. The form also reports your mortgage balance, mortgage insurance premiums, if any, and how much you paid in deductible mortgage points.
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Make Sure the Deduction Makes Sense
If you itemize deductions on a Schedule A, you’ll use Form 1098 to determine your mortgage interest deduction. Note that if you didn’t receive a Form 1098 because you paid less than $600 in interest, you can still deduct what you paid. To find out how much mortgage interest you paid without a Form 1098, look at your mortgage statements for that filing year. If you take the standard deduction instead, you won’t deduct your mortgage interest.
It’s smart to run the numbers first, because the deduction doesn’t make sense for many filers. Pennsylvania tax attorney and widely-recognized tax law writer Kelly Phillips Erb says, “The Tax Cuts and Jobs Act (TCJA) made the home mortgage interest deduction less attractive for many taxpayers. There are basically two reasons.
“One, the doubling of the standard deduction under TCJA means that fewer taxpayers are itemizing their deductions (you must itemize to claim the deduction). Two, the TCJA limited the interest deduction to the first $750,000 — or $375,000 for married taxpayers filing separately — of home mortgage debt for loans incurred after December 15, 2017 (taxpayers with mortgage debt incurred on or before December 15, 2017, may deduct interest on the first $1 million — or $500,000 for married taxpayers filing separately — of combined mortgage debt). Importantly, the deduction for interest on home equity debt was eliminated.”
On the other hand, those who recently borrowed are more likely to be able to deduct their mortgage interest, explains Beatriz Acosta, an Oregon tax preparer with Acosta, Morris and Associates.
“We saw with the interest rates drop during Covid a smart move by the majority of homeowners to refinance into a much more manageable mortgage payment; this in turn shifted some from using the itemized deduction to standard deduction,” Acosta says. “Now, with rates at 6%, new homeowners are paying out some of the highest mortgage interest I have seen as a preparer. Itemized deductions over the standard is the smarter choice.”
When Is Mortgage Interest Deductible?
There are three tests the mortgage interest expense must pass in order for it to be tax deductible.
— The money must have been used to buy, build or substantially improve your main home or a second home, but it doesn’t have to be a traditional home. “The IRS says only that it must be a qualified home,” says Erb, “which means your main home or your second home. But it doesn’t have to be a house–it could be a condo, trailer, boat or even a yurt. (Rule of thumb: it must have sleeping, cooking and toilet facilities.)”
— For mortgages taken out after December 15, 2017, interest on debt up to $750,000 is deductible. That limit is $1 million for mortgages taken out before that date. Taxpayers who are married and filing separately get half that amount.
— The deduction applies to homes or parts of homes used as your residence. If you rent it out or use it for business, that part of your deduction must be reported on other schedules.
Note that mortgage insurance is no longer tax-deductible.
When Are Mortgage Points Tax Deductible?
Mortgage points may also be called origination fees or loan discount fees. One point equals 1% of the loan amount. You can usually deduct mortgage points for the year in which you pay them as long as you meet these conditions:
— You used the loan to buy or build your primary residence, and the loan is secured by that home.
— Paying points must be a normal business practice in the area.
— The points must be reasonable for the area.
— You use the cash method of accounting (most people do), meaning you report income in the year you receive it and deduct expenses in the year you pay them.
— Points aren’t paid for other costs associated with home buying, such as appraisal fees, inspection fees or title fees.
— You didn’t borrow the money to pay points from your lender or mortgage broker.
— Points must be a percentage of the principal amount of the mortgage.
— Your settlement statement states the amount paid for points.
Points paid to refinance your mortgage must usually be deducted over the life of your loan. If you refinance with a 30-year mortgage, you can deduct 1/30th of the amount paid every year. If you sell your home or pay off the loan sooner, you can take the remaining deduction for the year in which you pay off the loan. The exception is if you refinance your loan again with the same lender.
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How to Deduct Mortgage Interest and Points
When you receive a Form 1098, total the amounts listed in Box 1 plus deductible points listed in Box 6. The IRS says on its Publication 936, “As a general rule, Form 1098 will include only points that you can fully deduct in the year paid. However, it may report points that you can’t deduct, particularly if you are filing married filing separately or have mortgages for multiple properties.” You’ll enter this amount on Line 8a of Schedule A.
You can’t deduct points paid for you by the seller. You can’t deduct interest paid on a wraparound mortgage that hasn’t been recorded with your county. And you can’t deduct points or interest on mortgage amounts exceeding the limit for deductibility.
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How to Calculate Your Interest Deduction for Mortgages Over $750,000
If your mortgage exceeds the limit (usually $750,000 for single and joint filers), you’ll have to do a little math to determine how much is deductible. Let’s assume that you bought a home with a $900,000 mortgage in March of last year and that you paid $40,000 in mortgage interest and points last year.
— First, calculate your average mortgage balance. Add the beginning balance to the balance on December 31 and divide by two. For older loans, add the balance on January 1 to the balance on December 31 and divide by two.
— If your starting balance was $900,000 and your ending balance was $890,000, your average balance would be $1,750 / 2 = $895,000.
— Divide $750,000 by $895,000 to get .84.
— Multiply $40,000 by .84 to get your deduction of $33,600.
That amount exceeds the standard deduction of $29,200 for a married couple or $14,600 for a single filer. So in this case, it makes sense for you to itemize your deductions and deduct your mortgage interest.
It’s important to consider these limits in your tax planning — and perhaps your personal life. “I would suggest avoiding married filing separately if you only have one home and are looking to divorce, “says Acosta. “Be amicable and [take] married filing jointly for your status.”
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1098 Tax Form: Mortgage Interest Statement and How to File originally appeared on usnews.com
