Mortgage interest deduction cap: Do you really need to care?

Young couple playing with their toddler in front of their house, confident they won't be affected by the mortgage interest deduction cap.Image: Young couple playing with their toddler in front of their house, confident they won't be affected by the mortgage interest deduction cap.

In a Nutshell

Tax reform capped at $750,000 the amount of mortgage and home equity debt for which you can deduct interest. For many housing markets, that’s still a lot of money. And, since the standard deduction has nearly doubled, do you really need to worry about the cap? Here are some things to consider.
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This article was fact-checked by our editors and Jennifer Samuel, senior product specialist for Credit Karma.

The Tax Cuts and Jobs Act made three changes to the tax code that limit the mortgage interest deduction for homeowners taking out mortgages or refinancing in 2018 and beyond.

In addition to lowering the eligible mortgage debt amounts, Congress also limited the deduction for home equity loans and nearly doubled the standard deduction amount.

Read on to learn more about the mortgage interest deduction and how each of these changes could impact your taxes in the future.

What is the mortgage interest deduction?

The mortgage interest tax deduction allows homeowners to deduct from their taxable income some or all of the interest they pay on a qualified home mortgage loan.

What counts

Before the 2018 tax year, homeowners getting a new mortgage were allowed to deduct interest paid on loans of up to $1 million secured by a principal residence or second home. Eligible loans included a mortgage to buy their home, a second mortgage, a home equity loan or a home equity line of credit, or HELOC.

“If the taxpayer owns rental properties, he can deduct the mortgage interest for those properties along with other rental expenses against rental income on Schedule E,” says Bonnie Lee, an enrolled agent with Taxpertise. “The mortgage interest deduction does not change for rental properties.”

What doesn’t count

If you refinance your mortgage and pay points, you generally can’t deduct the full amount of the points you paid, even if the new loan is secured by your home. But if you use part of the proceeds from the refinanced loan to improve your main home and meet certain tests, you may deduct part of the points related to the improvement.

How to claim the deduction

To take advantage of the deduction, you must itemize your deductions rather than take the standard deduction that the tax code provides, and you must have an ownership interest in a qualifying home.

What changed with the Tax Cuts and Jobs Act

Tax reform essentially made three changes that affected the mortgage interest deduction.

These changes are currently in effect through Dec. 31, 2025.

Here’s a summary of the changes.

  2017 tax year 2018 tax year and beyond
Mortgage deduction limit ●     $1 million of home acquisition debt, or $500,000 if you’re married filing separately ●     $750,000 of home acquisition debt, or $375,000 if you’re married filing separately
Home equity interest

●     $100,000 of home equity debt, or $50,000 if you’re married filing separately

●     Loans are qualified if they are secured by your home and don’t qualify as home acquisition debt

●     The separate deduction has been eliminated; home equity debt is rolled in with home acquisition debt

●     Loans are qualified if secured by your home and used to buy, build or substantially improve the home used as collateral

Standard deduction

●     $6,350 for single individuals and married couples filing separately

●     $9,350 for heads of households

●     $12,700 for married couples filing jointly and surviving spouses

●     $12,000 for single individuals and married couples filing separately

●     $18,000 for heads of households

●     $24,000 for married couples filing jointly and surviving spouses

What these changes could mean for you

First, it’s important to note that the mortgage interest deduction changes only apply to new mortgages. The law makes an exception for grandfathered debts. If you took on a qualified mortgage loan before Dec. 15, 2017, you may retain the previous limit of $1 million, or $500,000 if you’re married and filing separately.

To meet that deadline, you must have entered a binding written contract before Dec. 15, 2017, to close on the purchase of a principal residence before Jan. 1, 2018, and have purchased the home before April 1, 2018.

However, for new mortgages and home equity debt, the changes do apply. If you take out a mortgage in 2018 for a home that costs $1 million, you could potentially deduct interest on only the first $750,000 of that loan. If you live in an area with lower home costs, your mortgage and interest will probably fall well below the cap. However, if you live in a very expensive real estate market, your mortgage could exceed the cap even for a relatively modest home.

And, the only way that interest on a new home equity loan could be deductible is if you actually use it to buy, build, repair or improve your home. In other words, if you borrow against your home’s equity to fund your dream vacation, the interest on that loan is not likely to be tax deductible.

Should you itemize?

Of course, the change in the standard deduction could mean the mortgage interest deduction cap doesn’t matter to you — if you decide to take the increased standard deduction instead of itemizing your deductions for 2018. That’s because the mortgage interest deduction is an itemized deduction, so you can’t claim it if you take the standard deduction.

It generally makes sense to itemize only if the total amount of your itemized deductions exceeds the standard deduction for your filing status. And since the Tax Cuts and Jobs Act increased the standard deduction amounts across the board, it may become more challenging to have enough itemized deductions to make it worth it.

“The deduction for mortgage interest may be a moot point for many taxpayers after the passing of tax reform,” says Lee, “because the standard deduction was essentially doubled.”

To determine whether you should itemize, add up the eligible deductible expenses you paid during the year. These may include but aren’t limited to …

● Home mortgage interest
State and local income taxes or sales taxes (not both)
● Real estate and personal property taxes
● Charitable gifts and donations
● Unreimbursed medical expenses

Check the IRS website for a full list of eligible itemized deductions. Then, check the standard deduction amount for your filing status, which you can find in the table above. If your total itemized deductions are more than the standard deduction amount, you may decide that it’s better to itemize.

But if your standard deduction amount exceeds your total itemized deductions, you could be better off choosing the standard deduction.

Other home-related tax breaks to consider

While it may be more difficult to take advantage of the mortgage interest deduction, there are some other tax breaks available for homeowners. Here are a few.

Home office expenses

“If you are self-employed, you may deduct all costs associated with a bona fide home office,” says Lee, “as long as that office is used exclusively and on a regular basis for your business.”

Deductible expenses include actual expenses you incur for your home office and depreciation for the portion of your home that you use for your business. Keep in mind, you can’t take this deduction if you work from home as an employee for someone else. Tax reform suspended the deduction for unreimbursed employee expenses.

Home improvements

If you incur expenses to renovate or improve your home, they can reduce your tax burden when you sell the home later on.

These home improvement expenses increase the tax basis on your home, which is one of the numbers the tax code uses to determine your taxable earnings on a home sale. The higher your basis, the lower your potential tax bill.

Keep in mind minor repairs like fixing gutters probably won’t affect your home’s tax basis.

State and local taxes

If you live in a state, county or municipality that taxes residents, you may be able to take a federal income tax deduction for those costs. Tax reform established a cap of $10,000 ($5,000 for married taxpayers filing separately) for deducting the aggregate of all state and local taxes, including property taxes.

Energy-efficient updates

If you add a solar energy system to your home, you can take a tax credit worth 30% of the cost of the system. This credit decreases to 26% in 2020 and 22% in 2021, after which it expires.

Bottom line

As a homeowner, you might be concerned about how tax reform will affect your federal income taxes and the mortgage interest deduction. But depending on your situation — including the size and date of your mortgage — you may still be able to take advantage of it, along with other home-related tax breaks.

Or the cap may not matter to you at all if you decide the new higher standard deduction will give you a better tax benefit than itemizing deductions, including the mortgage interest deduction.

Relevant sources: IRS News Release: Interest on Home Equity Loans Often Still Deductible Under New Law | Tax Cuts and Jobs Act of 2017 | IRS Publication 936, Home Mortgage Interest Deduction | Federal Trade Commission: Home Equity Loans and Credit Lines | IRS: Itemize or Choose the Standard Deduction | IRS Publication 526, Charitable Contributions | IRS: Home Office Deduction | IRS: Simplified Option for Home Office Deduction | IRS: FAQs – Property (Basis, Sale of Home, etc.) | – 2017 Renewable Energy Tax Credits

Jennifer Samuel, senior tax product specialist for Credit Karma, has more than a decade of experience in the tax preparation industry, including work as a tax analyst and tax preparation professional. She holds a bachelor’s degree in accounting from Saint Leo University. You can find her on LinkedIn.

About the author: Ben Luthi is a personal finance freelance writer and credit cards expert. He holds a bachelor’s degree in business management and finance from Brigham Young University. In addition to Credit Karma, you can find his wo… Read more.