The word taxes could be the most hated 5 letter word in the English language. Many Americans feel as though they are taxed too much on their hard-earned money. More and more people are calling Tennessee home because it is a tax-friendly state, making it a great place to raise a family or retire. With that said, many of our clients ask us about the various real estate related tax breaks offered to homeowners. Anyone who owns real estate should be aware of the mortgage interest tax deduction, especially first time home buyers who may not be aware of this money-saving tip.
We understand - income tax, deductions, interest expense, can all be confusing topics. We're going to break everything down and start from the top.
What Goes Into Your Mortgage Expense?
Before we can dive into how interest deductions can assist you, let's start high-level by covering what goes into the monthly mortgage payments on your home.
Your home mortgage payment is typically an aggregate of numerous expenses. First and foremost, you have to pay the loan back, which is called the principal balance. If you borrowed $300,000 from the bank to buy a home, the bank will request the full amount to be paid back plus interest.
Insurance is also lumped into your mortgage expense. This includes homeowners insurance and private mortgage insurance (PMI) if your downpayment is less than 20 percent.
More often than not, property taxes are also included in the monthly mortgage payment. However, some property taxes are paid either once or twice per year and are not part of your recurring monthly mortgage payment.
Last but not least, the interest expense. The interest expense is simply the rate the bank charges you to borrow their money. Using the same example as above, if a borrower had a $300,000 mortgage, and the interest rate was 4%, that 4% rate would be the interest expense the borrower pays on the loan. The bank would be collecting a principal and interest expense with each mortgage payment. At the beginning of your loan, the majority of your monthly payment will go towards interest and over time, a larger percentage of your monthly payment will go towards the principal. This is what's known as mortgage amortization.
What Is A Mortgage Interest Deduction?
A mortgage interest deduction is an itemized deduction that enables the homeowner to subtract the interest expense they pay on a real estate loan from their taxable income. These loans can be used to purchase, build, or improve their primary home, secondary home, rental property, or even a vacation home in another state. Interest is a large portion of the home loan and itemizing this expense can yield a greater tax return for the individual, ultimately helping the homeowner keep more of their income in their pocket at the end of the year.
Is Mortgage Interest Still Deductible On Taxes?
Tax law can be tricky. There's a lot of information on the internet about this topic, and it's only right if we cover both the old law which was in place until 2017 and the new law, which began in 2018.
The old law
Up until 2017, homeowners could write off the mortgage interest on loans up to $1,000,000. This applied to your primary residence, second home, vacation home, home equity line of credit, or even a rental property, it didn't matter! Overall, this law resulted in greater tax deductions for homeowners with mortgages, which means fewer taxes and more money in their wallets each year.
The new law
The new tax law started in 2018 after the tax cuts and jobs act went into effect, and will be rewritten in 2025. This law allows homeowners to deduct the interest they pay on loans up to $750,000 in value. This itemized deduction can only be used on your primary home or second home. This does not apply to a vacation property. If your mortgage debt exceeds $750,000, you won't be able to deduct the full amount either.
The new law also does not allow the homeowner to deduct the interest paid on debt they have via a home equity loan, whereas that was possible with the old law. For example, If your primary mortgage is $400,000 and your HELOC is $200,000, you may only deduct interest on the $400,000 mortgage loan.
How Does This Deduction Work?
The mortgage interest tax deduction works by enabling homeowners to itemize the interest expense they pay on their home, permitting the mortgage loan amount does not exceed $750,000. The more deductions you have within your tax return, the more money you're likely to get back as you reduce your overall taxable income.
For instance, if you pay income tax on a salary of $125,000, and deduct $15,000 interest write-offs on your tax return, you'll be taxed as though you made $110,000 ($125,000 salary - $15,000 interest paid =$110,000).
Who Qualifies For This Tax Deduction
To qualify for mortgage interest tax deduction, a homeowner must meet the following requirements.
- The homeowner files an IRS form 1040 and itemizes their deduction
- The mortgage must be a secured debt for a qualified home What is a qualified home? The residence must be your primary or secondary home.
Can I Deduct My Mortgage Interest If I Take The Standard Deduction?
There is a tax crossroads many people face each year. Should they itemize their deduction or should they go with the standard deduction?
When you choose to itemize your deduction, you can write off many other expenses. These expenses can include; property taxes, income or sales taxes, vehicle fees, charitable donations, and even job-related expenses. It's important to note, all expenses are not eligible to be itemized, and you must have thorough documentation of each expense including the receipt from the transaction.
The standard deduction does not allow the homeowner to writeoff as many expenses, but the interest you pay on your mortgage is still eligible. In the 2019 tax year, the standard deduction amount was:
- $12,200 if you were single or married filing separately
- $18,350 if you were the head of household
- $24,400 if you were married filing jointly The short answer is, yes, you can deduct mortgage interest if you take a standard deduction. However, the actual amount that is eligible to be deducted may not be what you actually paid. It's best to discuss your tax strategy with a CPA to make sure you are doing everything correctly and maximizing your deductions.
How Do Tax Deductions For Home Mortgage Interest Affect the Economy?
This law helps the economy
There are some economists that believe the mortgage interest tax deduction promotes more positive economic activity. Americans who utilize this deduction can see a greater tax return, resulting in more money in their pocket. As shown time and time again, the more money Americans have in their pockets, the more they'll spend. Spending is the foundational piece to economic activity and many local and national businesses benefit from an increase in consumer spending - think about how the stimulus deal enacted for the COVID-19 pandemic impacted the economy.
This law hurts the economy
The other point of view is, homeowners will continue to count on this interest deduction and as a result, purchase more expensive homes by way of larger loans. This isn't always good because tax laws change, and a benefit you once counted on may not be available in the future. As a result, this could cause more people to default on their loans. Additionally, the mortgage interest deduction can be viewed as offering an incentive to take on a greater mortgage payment/debt, which can be seen as counterintuitive to boosting the economy.
What do we think?
If you were to buy a home that is well within your budget, you'll appreciate having greater deductions each year to help you save some money. You'd be free to spend this money on whatever your heart desires, for example, a bathroom upgrade or a new deck. However, the main argument for the opposing view is, deductions can lead to excess debt spending. Just because you are qualified for a more expensive mortgage doesn't mean you should take on that financial obligation. Your annual mortgage payments should typically be no more than 25-30% of your annual income.
Tennessee, A Tax-Friendly State
Tennessee is a great place to live. Not only do the residents enjoy our culturally rich cities, the endless amount of outdoor activities, professional and college sports teams, and a thriving local economy, but Tennessee residents also benefit from the laws on state and local taxes.
First and foremost, Tennessee residents do not pay state income taxes. When you compare that to our friends in the North East or West Coast, this is unheard of! Imagine how much more money you'd have in your pocket if you didn't have to pay state income tax.
Additionally, state and local taxes are favorable. Property taxes are low when you compare them to other parts of the country, and you certainly get a lot of bang for your buck with our less expensive cost of housing!
Retirees that live in Tennessee do not pay tax on the income they receive from their pensions or 401-k's. Combine the benefits of no income tax on your retirement money, with a world-class healthcare system, and it's evident why more and more retirees are flocking to the Volunteer State to live out their golden years.
Tennessee is also one of just 9 states that do not tax capital gains. That doesn't mean Tennessee residents can avoid paying the IRS federal tax on capital gains, but on a state level, there is no capital gain tax! Whether you're selling your home or stocks, enjoy the freedom of no state income tax on your capital gains, but be sure to put some profit aside for our friends at the IRS on a federal tax level.
Closing Tax Remarks
Although homeowners cannot write-off the interest expense on loans of 1 million dollars, there is still a lucrative tax law enabling homeowners to keep more of their hard-earned money. As long as your loan does not exceed $750,000, the interest expense you pay can be used to reduce your taxable income.
Taxes are never enjoyable, and they bring a great deal of fear, anxiety, and emotion to millions of Americans. There are a few powerful tax laws that Americans can use to benefit their overall financial picture.
Felix Homes, We Can Help
Felix Homes is a local low commission real estate brokerage. We service the greater Nashville area, and on average, help our clients keep thousands of dollars in home equity with each transaction. Whether you're moving to Tennessee for business, personal reasons, or to enjoy your retirement years, we'd be happy to help.
It doesn't matter if you're selling your home, or if you're a first time home buyer, we'll be sure to save you a lot of money in real estate commission fees. We charge a 1% commission to sell your home and offer a savings of 1.5% when we help you buy a home. On average, or lower fees help our clients keep an extra $8,100 on each transaction.
Our low-cost model does not mean you'll be getting a lower quality of service. We are a full-service real estate brokerage, we just don't believe in the high-cost commission fees other brokerages charge. The real estate market is booming, home prices are skyrocketing, yet most commission fees remain at 3%! That just doesn't make sense in our eyes, and we pledge to be your low cost, high service realtor.
If you'd like to tour a property, request more information, or just pick our brains on the real estate market, please drop us a line! You can contact us any time by emailing firstname.lastname@example.org or by calling 615-422-4277.