The value of the mortgage interest deduction is high but it has limitations. My mortgage interest for last year amounted to about $9,000. That’s the amount I itemized on my Schedule A to reduce my tax liability. They call the mortgage interest deduction a “below the line” deduction because it’s deducted after AGI is calculated. I had some other itemized deductions as well. They totaled about $16,000 in my case. I’d still be eligible to reduce my tax liability by the standard deduction amount of $12,600 if I didn’t itemize. I wonder what the real economic impact of the mortgage interest deduction is (you wonder such things when you’re a lame-o CPA).

Above or Below the Line

Above the line deductions are those that reduce your Adjusted Gross Income (AGI). Above the line deductions are better than below the line deductions because they reduce your AGI. A lower AGI is always better because many income phaseouts are tied to it. You can remember above the line deductions by using the mnemonic “I EMBRACED EHF”. I got this from Roger Philipp (rockstar CPA and all around great guy).

I – Interest on student loans

E – Employment tax (50% self employment tax, 100% medical premiums)
M – Moving expenses
B – Business expenses
R – Rent, royalty and flow-through entities
A – Alimony
C – Contributions to retirement
E – Early withdrawal penalty
D – Jury “D”uty pay

E – Education
H – Health savings account
F – Farm income

You can list all of these deductions on the face of your 1040.

above the line deductions

Below the line deductions are ones that you deduct from AGI. They come below AGI on the tax form. They’re less valuable than above the line deductions because they don’t make your AGI lower. Most phaseouts are based on your AGI. So if you can get your AGI lower, you won’t hit the phaseouts and can reduce your tax liability. You can remember these by using the mnemonic “COMMITT” (yes, 2 T’s).

C – Charitable Contributions
O – Other Misc deductions (Not subject to 2% AGI)
M – Misc deductions (subject to 2%)
M – Medical Expenses
I – Interest Paid (this is where the mortgage interest deduction fits in)
T – Taxes Paid but NO FBI
T – Theft or casualty

where FBI is:
F – Federal tax
B – Business and rental property taxes
I – Inheritance tax

below the line deductions

Is There Any Real Value in the Mortgage Interest Deduction

I think there’s value in the mortgage interest deduction but it’s not dollar-for-dollar like people usually talk about it. People will say, “I wrote off $10,000 in mortgage interest” but what if the only other below the line deduction they had was property tax for $2,600? Then their itemized deduction would equal $12,600, the exact same as if they filed under the standard deduction for a married couple filing jointly. Their mortgage interest wouldn’t matter at all in this case. They’d just feel as though they’re smart by having a mortgage interest deduction. When you actually research this stuff, it’s not as clear cut as you think.

The real value in the mortgage interest deduction is when you have a decent amount of Schedule A below the line deductions (COMMITT) and you’re in a relatively high tax bracket. The interest deduction, when added to charitable contributions, taxes paid, real estate taxes, and medical expenses becomes of greater value to Joe Taxpayer. You can pretty easily get over the standard deduction amount, even if you live in a lower cost of living area. Being in a high tax bracket also helps because the deduction is taken off your highest income (it’s reduced at the margin).

You can deduct mortgage interest on $1,000,000 worth of primary on secondary home mortgage and an additional $100,000 on a home equity line of credit as long as it’s not used to purchase property for a primary or secondary home. Section 163 of the ole’ tax code considers the $1,000,000 to be “acquisition debt” for a “qualified residence”. Check with a good tax accountant if you’re bumping up against the limits. There have been court decisions that you could use deduct $100,000 in home equity even if it was used as “acquisition debt”.

Check the Phaseouts

All good things must come to an end. The mortgage interest deduction phases out once your AGI hits the current Pease limitations. Pease limitations do reduce the total amount of deductions you can claim on your return. Like almost everything else with the IRS, the phaseout for deductions is a bit complex. Your itemized deductions will be reduced by the smaller of the following:

  • 3% of AGI above the applicable threshold (currently $311,300 married filing jointly; or
  • 80% of the amount of itemized deductions that are subject to the limit (taxes, interest, charity, business expense, & misc other deductions)

Example: Let’s say you are a MFJ taxpayer with an adjust AGI of $500,000 and your itemized deductions total $100,000. The phaseout will hit you at a rate of 3% over the threshold. Since the overage is $188,700 ($500,000 AGI – $311,300 threshold), your allowable deductions are reduced by $5,661, resulting in an allowable deduction of $94,339. You can see that this phaseout isn’t too bad. You have to earn a lot to reduce your deduction substantially. (Note: The Alternative Minimum Tax isn’t factored in here and may also affect your itemized deductions.)

Recommendation

I recommend carrying a big long-term mortgage in retirement, up to the amount that makes sense. There are many benefits to carrying a mortgage, not just the interest deduction. The mortgage interest deduction gives you the greatest value when you’re in a higher tax bracket and you have sizable itemized deductions. I wouldn’t worry too much about the Pease phaseout since it take such a high income to really make a difference in your deductible amount.