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Most people assume their home is a great investment. I know I did when I bought my first home. Through homeownership, you can build wealth and best of all, lower your taxes substantially through the mortgage interest tax deduction, right?
Not necessarily. In actuality, the mortgage interest tax deduction may be one of the most misunderstood tax deductions on the books today.
A Little History
In 1913, interest deductions were first introduced into the tax code. All interest, not just mortgage interest, was deductible on tax returns starting that year. This included interest on personal loans such as credit card debt. However, the deduction excluded the first $3,000 of income for singles and $4,000 of income for married couples. Thus, the deduction affected less than 1% of the population at that time.
A little over 30 years ago, the Tax Reform Act of 1986 limited the interest deductions to just mortgage interest. The hope was that it would spur homeownership.
Mortgage Interest Tax Deduction
The mortgage interest tax deduction allows taxpayers to deduct interest paid on their mortgage up to $1 million in principal on their home. If your mortgage is $2 million, only the interest on the first $1 million of principal is tax-deductible. In addition, you can also deduct the interest of up to $100,000 of home equity debt.
Most people qualify for the mortgage interest tax deduction as they don’t come anywhere near the $1 million principal limit.
Additionally, the interest deduction only applies to one’s first and second homes. Thus there is no tax incentive to buy a third home. However, this could change according to whatever tax plan is passed later this year.
To qualify for a mortgage deduction, you must itemize your taxes when you file. You would also need to forgo the standard deduction. As of 2017, the standard deductions are: $6,350 for single people, $9,350 for “head of households”, and $12,700 for married couples filing jointly.
In order for the mortgage interest deduction to help your tax situation, the deductions on your Schedule A must exceed the standard deduction. Otherwise, you can only take the standard deduction and will not receive any additional tax benefit.
Let’s say you and your spouse paid $14,000 in mortgage interest on your home in 2017. You would receive a $1,300 benefit over the standard deduction of $12,700. If you are in the 20% tax bracket, you could only claim $260 in tax benefit.
That hardly seems worth it if you paid $14,000 in mortgage interest.
Average Savings of Mortgage Interest Deductions
The average savings in 2016 was $1,918. However, those with incomes over $200,000 saved $4,149. Meanwhile, the average American family, who earns less than $75,000 per year, saved less than $700.
|Mortgage Interest Deduction|
|Returns in thousands, Money amounts in millions of dollars|
|$10,000 to $20,000||138||$40|
|$20,000 to $30,000||350||$132|
|$30,000 to $40,000||668||$337|
|$40,000 to $50,000||1,153||$602|
|$50,000 to $75,000||4,692||$3,650|
|$75,000 to $100,000||5,074||$5,538|
|$100,000 to $200,000||14,597||$24,853|
|$200,000 and over||7,178||$29,782|
Source: The Joint Committee on Taxation
Source: The Joint Committee on Taxation
As you can see, the real winners are those who earn $200,000 and over. Although you may have heard that the mortgage interest tax deduction is a great benefit, it appears that it really only greatly benefits the wealthy.
Home Size & Homeownership
According to the Wall Street Journal, the average house size in the Washington, D.C area would be almost 1,400 square feet smaller if the mortgage interest tax deduction did not exist. After all, the mortgage interest deduction was first enacted to promote home ownership.
However, although the deduction has increased the size of housing, it has done very little to encourage people to buy homes. In fact, US homeownership rates are similar to that of Canada and Australia, but neither Canada nor Australia offer mortgage tax deductions.
So, the next time someone tells you to obtain or keep your mortgage because of the wonderful tax benefits, you should take their advice with a grain of salt.