There are still several income tax deductions available to the everyday taxpayer. Several years ago, all sorts of interest, including credit card interest, was available as an income tax deduction. During the overhaul of the income tax code way back in 1986, several popular deductions were eliminated. We’ll talk about some of them but it’s important to note upfront that any tax questions should be directed at your accountant or tax professional. This article will focus on mortgage-related expenses that may qualify for most taxpayers.
Today, most taxpayers can deduct an amount for charitable donations and contributions. Medical expenses may be eligible for all expenses exceeding 10 percent of your adjusted gross income. There is a SALT deduction, which stands for state and local tax deduction. Areas for a home office, self-employment expenses, and certain educator expenses may be eligible for a deduction. But the most common one and the biggest deduction for most consumers is mortgage interest.
It’s also probably a good time to point out the difference between a tax deduction and a tax credit. A tax deduction reduces the overall adjusted gross income which then reduces the amount of taxes paid. A tax credit reduces the total amount due. If there is an available $10,000 deduction available and income is $100,000, the deduction reduces the taxable income to $90,000. With a tax credit, if there are taxes due of $10,000, a $10,000 tax credit would reduce taxes due to zero.
Mortgage interest was kept as a deduction back in 1986. Mortgage companies and real estate groups, in general, worked to keep the deduction intact. The thought behind a mortgage interest deduction is it helps to spur the real estate industry. Real estate purchases do have a ripple effect on the economy as a home sale generates a lot of third party revenue. Beyond the commissions real estate agents earn, others benefit from a home sale. Certainly insurance companies receive a benefit when issuing an insurance policy to cover a home. Various third party services related to real estate also receive income upon the sale of a home. But so do furniture stores, hardware stores, and lawn maintenance firms. It’s a fairly wide swath of businesses that benefit.
It’s not exactly clear if a mortgage interest deduction does spur homeownership. It’s not always clear that someone bought a house just because of the available interest deduction. It’s certainly a benefit, no doubt, but as a primary motivation, probably not. The mortgage interest deduction is an excellent side-benefit of homeownership. After all, rent does not qualify for any deduction at all.
There’s another item that’s mortgage-related that can be deducted. Discount points may be a tax deduction for the year paid. They’re referred to as discount points because paying some discounts, or reduces, the interest rate on the mortgage for the entire life of the loan. But why are discount points tax deductible? Points are considered a form of prepaid interest. Therefore, since mortgage interest is tax-deductible so too are points. Lenders can collect mortgage interest over the life of the loan and can also collect upfront interest in the form of discount points. The deduction is made available for the year in which points were paid.
With a refinance, there’s a slightly different twist. Borrowers have the option of paying points or not paying points, whether it’s for a purchase or a refinance. Either way paying points reduces the rate. The tax deduction for a refinance however spreads the discount point over the life of the loan. If it’s a 30 year fixed rate term, the point deduction is spread out over 30 years. Paying points for a refinance may not make sense in all instances.
You should speak with your loan officer about whether or not to pay any points makes sense. In general, discount points will lower a 30 year fixed rate by about 0.25 percent for each 1% point paid. Most often paying points on a refinance may not make much sense, but again a lot depends on the time you plan to live in the home. At Coast2Coast we can help you do the math and decide whether or not paying points is worth it or not. If it is and you do pay points, you’ve at least got a slightly lower tax bill at the end of each year.
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