For many years, the mortgage interest deduction has been one of the most cherished tax deduction, and one that is not available in many other countries. However, the myth of this deduction is often stronger than the reality. That’s especially true in the wake of the 2017 Tax Cut and Jobs Act.
The TCJA did not directly affect the mortgage interest deduction. Many modifications in this area would probably be politically unacceptable. However, the TCJA did indirectly affect this deduction, and in a very big way.
There are no easy answers in the mortgage prepayment debate. Prepayment may or may not be a good idea, based on the homeowner’s financial status, financial goals, and other factors. All a certified tax coach, or anyone else, can do is give people as much information as possible. This data is even more important now, because the mortgage prepayment question often involves more than just the mortgage interest deduction.
Mortgage Interest and Property Taxes Before 2018
Before 2018, property taxes, school taxes, and all other state and local taxes were 100 percent deductible. This deduction supplemented the mortgage interest deduction. So, if a family paid $22,000 a year in mortgage interest payments and $5,000 in SALT (State And Local Taxes) property taxes, it made perfect sense to itemize. The $29,000 total mortgage write-off well exceeded the $12,000 standard deduction.
For this reason, many homeowners borrowed more money to take advantage of the mortgage interest deduction. Each installment payment does not have the same principal/interest division. At first, the bank applies most of each payment to interest. Later, after the interest is largely paid off, the payments go toward principal reduction. So, later in the repayment period, many homeowners refinanced their loans to increase their interest payments, and therefore their mortgage interest deductions.
Mortgage Interest and Property Taxes After 2018.
The 2017 TCJA doubled the standard deduction for married couples to $24,000. So, to realize a tax benefit, itemized deductions must be incredibly high. In most cases, that’s not true..
If they itemize under the new law, our hypothetical family only realizes a $2,000 deduction ($22k in mortgage interest against a $24k standard deduction). Given the ease of checking the standard deduction box as opposed to the complexity of itemizing mortgage interest, that’s not much of a break..
Additionally, our hypothetical family can only deduct $10,000 in SALT taxes under the new law. So, their $5,000 property tax bill is probably either not fully deductible, or not deductible at all.
As a result, prepaying a mortgage to pay down debt may be a good idea. That money could be invested elsewhere. Before embarking on this path, make sure that the bank applies extra money to the Unpaid Principal Balance (UPB). The bank does not automatically do so. Additionally, if the loan has a large prepayment penalty, an early payoff may be a zero-sum game, at best.
To see which approach is best for you, reach out to a certified tax coach near you. Ready to start saving real money on your taxes? Call us today at 925-240-2886 to schedule your free consultation. As a thank you for scheduling your consultation, we’ll provide you with a book, The Great Tax Escape.