The Evolution Of Mortgage Deduction: Understanding Recent Changes

The mortgage interest deduction is a tax benefit that allows homeowners to reduce their taxable income by deducting the amount of interest they've paid on their mortgage. The Tax Cuts and Jobs Act (TCJA) of 2017 (or 2018, according to one source) changed the amount of interest that can be deducted to \$750,000 for new loans taken out after December 15, 2017, down from the previous limit of \$1 million. This change has been a source of controversy, with some arguing that it disproportionately benefits high-income Americans and reinforces racial disparities.

The 2017 Tax Cuts and Jobs Act (TCJA)

Another change made by the TCJA was the distinction between acquisition debt and equity debt. Acquisition debt is incurred in acquiring, constructing, or substantially improving a qualified residence and must be secured by the residence. Equity debt, on the other hand, includes other debts secured by the residence, such as home equity loans or lines of credit used for purposes other than improving the property. Under the TCJA, all equity debt is non-deductible, even if incurred prior to December 15, 2017. However, if the proceeds from equity debt are used to buy, build, or substantially improve the property that secures the debt, it can be considered acquisition debt and may be deductible.

The TCJA also increased the standard deduction for individual filers, joint returns, and heads of household between 2017 and 2018. This change made it less likely that taxpayers would benefit from claiming itemized deductions, including qualified residence interest. Additionally, the TCJA introduced a $10,000 ceiling on the state and local tax (SALT) deduction, which reduced the tax benefit for taxpayers in areas with higher-value real estate and higher SALT burdens.

Overall, the changes introduced by the TCJA had a significant impact on the mortgage interest deduction, affecting both the type and amount of interest that could be deducted. These changes were intended to incentivize homeownership and make owning a home more affordable for taxpayers. However, there has been some opposition to these changes, with critics arguing that the deduction primarily benefits high-income Americans and encourages the purchase of larger and more expensive homes.

Deduction limits

The mortgage interest deduction allows homeowners to reduce their taxable income by deducting the amount paid in mortgage interest. The Tax Cuts and Jobs Act (TCJA) of 2017-2018 changed the type and amount of mortgage interest that can be deducted. The TCJA introduced a lower limit on the maximum amount of home acquisition indebtedness for the deduction, set at $750,000 for new loans taken out after December 15, 2017. This limit applies to acquisition indebtedness incurred after December 15, 2017, for tax years starting after December 31, 2017, and before January 1, 2026. The previous limit was $1 million.

For mortgages acquired after December 15, 2017, taxpayers can deduct interest paid on indebtedness of $750,000 or less. If the mortgage indebtedness exceeds this amount, only a percentage of the interest can be deducted. This change reduces the tax benefit for taxpayers, particularly those with higher-value real estate and higher state and local tax (SALT) burdens. The percentage of taxpayers with a tax benefit from the mortgage interest deduction fell from 20% in 2017 to 8% in 2018.

The TCJA also differentiates between acquisition debt and equity debt. Acquisition debt is incurred in acquiring, constructing, or substantially improving a qualified residence and must be secured by the residence. Equity debt refers to all other debt secured by the residence, such as home equity proceeds used for non-acquisition purposes. Under the TCJA, all equity debt is non-deductible, even if incurred before December 15, 2017. However, if the proceeds from equity debt are used for acquisition purposes, it can be considered acquisition debt, and different rules apply depending on when it was incurred.

The mortgage interest deduction has been criticised for disproportionately benefiting higher-income households and contributing to racial disparities. Opponents argue that it encourages the purchase of larger and more expensive homes and primarily benefits high-income Americans. As a result, there have been calls for its repeal or reform.

Itemised deductions

The mortgage interest deduction allows you to reduce your taxable income by a certain amount of money you've paid in mortgage interest during the year. To claim this deduction, you must itemize your deductions on Schedule A (Form 1040). This means you'll need to fill out additional forms to list each deduction and submit records, receipts, and other documents that validate them.

You can deduct the mortgage interest you paid during the tax year on the first $750,000 of your mortgage debt for your primary home or a second home. If you are married and filing jointly, the limit is $750,000, while it is $375,000 if you are married and filing separately. If all the debt was incurred before December 16, 2017, the limit is $1 million ($500,000 if married and filing separately).

You can also deduct as home mortgage interest any late payment charges or prepayment penalties, as long as they were not for a specific service performed or cost incurred in connection with your mortgage loan. If you sell your home, you can deduct your home mortgage interest paid up to the date of the sale. Additionally, if you and your ex-spouse both own a home and pay the mortgage, you can each deduct half of the total payments.

It's important to note that the mortgage interest deduction only applies to secured debt on a qualified home in which you have an ownership interest. The loan must be secured by the home that is the main residence or a second home, and the funds must be used to buy, build, or substantially improve the home. Interest on home equity loans and lines of credit is only deductible if the borrowed funds are used for these purposes.

Equity debt

The Tax Cuts and Jobs Act (TCJA) of 2017 introduced a lower limit on the maximum amount of home acquisition indebtedness for the purpose of mortgage interest deduction. This lower limit applies to acquisition indebtedness incurred after December 15, 2017, for tax years between December 31, 2017, and January 1, 2026. The TCJA also prohibits the deduction of interest from home equity debt for the same tax years.

Home equity debt is a loan taken out for reasons other than buying, building, or substantially improving a home. For example, if you take out a home equity loan or line of credit to pay off personal living expenses, such as credit card debts, you may be able to deduct the interest paid. However, if the borrowed funds are used to buy, build, or substantially improve the taxpayer's home, the interest on the loan is deductible.

The mortgage interest deduction is available for up to $750,000 in mortgage debt if you're married and filing jointly, single, or the head of a household. If you're married and filing separately, the limit is $375,000. It's important to note that the mortgage must be secured by the taxpayer's main or second home, known as a qualified residence, and meet other requirements.

The TCJA's lower limit on home acquisition indebtedness can impact homeownership decisions. For example, if an individual purchases a new home with cash, the IRS provides a 90-day window after the purchase to take out a mortgage for it to be considered acquisition indebtedness. Mortgages applied for after this period are considered home equity indebtedness, with stricter deductibility limits.

Homeownership

Prior to the TCJA, the mortgage interest deduction had a ceiling of $1 million in home acquisition indebtedness. This meant that homeowners could deduct the interest paid on their mortgage debt up to $1 million. However, with the introduction of the TCJA, this limit was reduced to $750,000 for new loans taken out after December 15, 2017. This change applies to tax years beginning after December 31, 2017, and before January 1, 2026, and is expected to sunset on December 31, 2025.

The TCJA also made changes to the type of mortgage interest that can be deducted. Under the new law, acquisition debt, which is incurred in acquiring, constructing, or improving a qualified residence, remains deductible. On the other hand, equity debt, which includes other debts secured by the taxpayer's residence, such as home equity loans or lines of credit, is no longer deductible unless the proceeds are used to buy, build, or substantially improve the property.

The impact of these changes on homeownership decisions is a topic of interest. The lower limit on deductible mortgage debt may affect the affordability of owning a home, especially for those with higher-value mortgages. Additionally, the changes to the type of mortgage interest that can be deducted can influence the tax benefits derived from homeownership. It is worth noting that the TCJA also increased the standard deduction, making it less likely for taxpayers to benefit from itemized deductions, including qualified residence interest.

Overall, the changes to the mortgage interest deduction under the TCJA have had varying effects on taxpayers. While some may still benefit from the deduction, especially those with lower mortgage debts, others, particularly those with higher-value mortgages, may find it more challenging to claim the same level of tax benefits as before.

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