The Maximum Mortgage Tax Deduction Depends On Income

The US government has blessed us with the ability to deduct our mortgage interest expense from our income. This thereby enables us to lower our tax liability. The maximum mortgage tax deduction ultimately depends on income, which I’ll get into below.

Although you could deduct mortgage interest on up to $1 million in mortgage indebtedness in the past, that’s no longer the case. The amount was lowered to $750,000 due to the Tax Cut & Jobs Act passing in 2017 for 2018 and beyond.

While the decrease is unfortunate for property owners with large mortgages, at least we still have something. If you go to Canada, Australia, Asia, and Europe, there is no such mortgage tax deduction benefit. Then again, at least they’ve got cheap healthcare!

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To understand the maximum mortgage tax deduction, we should first do an overview of the marginal income tax rates in America.

Marginal Income Tax Rates

Given the US has a progressive tax system, the higher your income, the more valuable your mortgage interest income deduction becomes. Homeownership with a mortgage is absolutely the best tax shield for everyday folks out there.

Further, owning rental properties is one of the best ways to generate tax-efficient semi-passive income. Rental properties are a focus of mine in 2022+ as the value of cash flow has gone way up.

Let’s take a look at the latest marginal tax rates for singles and married couples.

Single Filing Status For 2022

• 10% on taxable income from $0 to $9,875, plus
• 12% on taxable income from $9,876 to $40,125, plus
• 22% on taxable income from $40,126 to $85,525, plus
• 24% on taxable income from $85,526 to $163,300, plus
• 32% on taxable income from $163,301 to $207,350, plus
• 35% on taxable income from $207,351 to $518,400, plus
• 37% on taxable income over $518,400.

Married Filing Jointly or Qualifying Widow(er) Filing Status For 2022

• 10% on taxable income from $0 to $19,750, plus
• 12% on taxable income from $19,751 to $80,250, plus
• 22% on taxable income from $80,251 to $171,050, plus
• 24% on taxable income from $171,051 to $326,600, plus
• 32% on taxable income from $326,601 to $414,700, plus
• 35% on taxable income from $414,701 to $622,050, plus
• 37% on taxable income over $622,051.

The more you make, the higher the marginal tax rate you have to pay. It’s important to know your top marginal tax rate because after you earn over roughly $200,000 as an individual and $400,000 as a couple, your mortgage tax deduction gets reduced thanks to the Alternative Minimum Tax (AMT).

AMT is in effect so that higher-income Americans don’t end up getting 100% of all the tax benefits.

Also, be aware that Joe Biden is looking to raise taxes on individuals or households making more than $400,000 a year. Hopefully, Joe Biden will also increase the maximum mortgage tax deduction to $1,000,000. However, we can’t be certain for now.

The Maximum Mortgage Tax Deduction Can Help You Save Money

What’s important to note is that if you are in the top tax bracket, you get 37 cents back for every one dollar in interest you pay on your mortgage.

If you also pay State income tax, you can see how your marginal tax rate can easily reach 50% on your last dollar of income earned! The beauty of the mortgage interest deduction is that it applies to your marginal income, and therefore your highest marginal tax rate.

Even if you don’t have a mortgage large enough to take full advantage of the maximum mortgage tax deduction, that’s ok. Utilize as much of the mortgage interest tax deduction that you’re eligible for to save money on your taxes.

For those in the 12% Federal tax bracket or below, a mortgage tax deduction isn’t very beneficial. You would need to have a massive mortgage at a 12% Federal marginal tax rate to receive any benefits because the standard deduction is $12,000 for singles and $24,000 for married couples.

When you’re in the 24% marginal tax bracket, that’s when homeownership starts making more sense provided you follow the 30/30 rule for home buying.

Homeownership Is Worth More To Higher Income Earners

Example #1

Say you earned $518,400 in 2020 as an individual tax filer (ie single status). Your income from $207,351 to $518,400 is taxed at a 35% Federal Tax rate. 

If you paid $50,000 in mortgage interest for 2020, you get to reduce your taxable income by $50,000 from $518,400 to $468,400. As a result, you are paying $50,000 X 35% = $17,500 less in Federal taxes!

Unfortunately, AMT will likely knock that mortgage interest tax deduction back by ~30% – 50% given your income is so high as an individual. But still, getting a $8,750 – $12,250 tax deduction is pretty good.

Example #2

Say you earned $136,000 in 2020. Roughly $50,000 of your income will be taxed at a 24% federal tax rate.

If you somehow managed to pay $50,000 of mortgage interest for 2020, your taxable income is only $86,000. As a result, you are paying $50,000 X 24% = $12,000 less in Federal taxes.

But again, you would have to take out a massive mortgage to pay $50,000 in mortgage interest a year. For example, a $2 million mortgage at a 2.5% interest rate would get you there. But no lender would lend you $2 million on an income of only $136,000. The largest mortgage you’d probably get if you had stellar credit is $650,000 (5X your income).

A 2.5% mortgage rate on a $650,000 mortgage equals $16,250 in mortgage interest. Therefore, you’d really only be saving at most $16,250 X 24% = $3,900 in income tax.

One can therefore conclude that owning a home with a mortgage is more beneficial for those who have higher incomes. One can also conclude there is an asymmetric benefit for those who have higher incomes.

Income Phaseout

Taxes are complicated. There is an income threshold where once breached, every $100 over minimizes your mortgage interest deduction. That level is roughly $200,000 per individual and $400,000 per couple for 2021.

Here’s how the income phaseout works with the previous income threshold for an individual of $166,800.

Just know that if an individual has an adjusted gross income of over $166,800 your mortgage interest starts to get phased out. For every $100 of income over $200,000 you lose $3 of itemized deduction X 33.3% up to a maximum loss of 80 percent of your itemized deductions. Talk about another overly complicated rule the IRS/government has implemented!

Example: You make $266,800 and you have $50,000 in mortgage interest deductions. Take $266,800 – $166,800 = $100,000. Then take $100,000 X 3% = $3,000. Finally, take $3,000 X 33.3% = $999. You can now only deduct $49,001 ($50,000 – $999) from your income instead of originally $50,000.

In my example of the person making $518,000 and paying $50,000 in mortgage interest for the year, the homeowner can only deduct about $45,800 given the phaseout. As a result, the homeowner has to pay $2,000 more in taxes.

Note on The Alternative Minimum Tax

The A.M.T. bars any deduction for interest payments on a home equity loan when loan proceeds are used for purposes other than home improvements. Regardless of your income, you can deduct the mortgage interest.

However, deductions for property taxes and for state and local income taxes and exemptions for the taxpayer and dependents must be added back to arrive at the taxpayer’s alternative minimum taxable income. If the tax to be paid using this method is higher than that from the regular computation, the higher amount must be paid.

Bottom line, you are not going to get the full mortgage interest tax deduction if your individual income exceeds $200,000. So don’t be surprised when it comes tax time.

The Best Income To Take Advantage Of The Ideal Mortgage Amount

Given there is an income phaseout and AMT, I say the ideal income a homeowner should shoot to earn is roughly $300,000 per married couple or $250,000 per individual. $250,000-$300,000 is a high enough income to allow for a good life, no matter where you live in America.  

With a mortgage interest deduction among other deductions, you can bring your AGI down to $200,000 to $250,000 to fly right under the radar of the government’s income threshold to increase taxes.

$300,000 is really the amount of household income I think that is required to live a middle-class lifestyle today in a big city. After taxes, $300,000 is roughly $210,000.

The maximum mortgage amount to get if you want to maximize mortgage interest deductions is $750,000. Therefore, for more expensive homes, you will simply have to put a greater amount down.

Maximum Mortgage Tax Deduction Review

• Homeownership is worth more to higher income earners, but only up to a point.

• Mortgage interest phaseout starts at around $200,000 and has a maximum phaseout of 80% of the mortgage interest.

• The ideal income to earn for homeowners is around $250,000 for singles and $300,000 for couples.

• Earning more than $250,000-$300,000 doesn’t do much to improve happiness. It might make you mad due to higher taxes.

• The ideal mortgage amount for the ideal income is therefore $750,000, which equals 3X a household income of $250,000. This also fits perfectly with my 30/30/3 rule for home buying.

• The US government is pro homeownership, therefore take advantage of the benefits.

• You get $250,000 in tax-free profits if you sell your house and are single, double the amount if you are married.

• Single filers get a standard deduction of $12,400 for 2020 ($24,800 for married filers). The government allows you to automatically choose between standardized or itemized, whichever is greater. Given we are talking about $750,000 dollar mortgages as the ideal mortgage amount, itemized deductions will always be chosen.

Note: I am not a real estate lawyer or accountant. But, I do have a multiple property portfolio valued at well over $3 million dollars. In addition, I have spoken with many accountants and real estate lawyers about this subject. I am an active manager of lowering my tax bill and building wealth for the long run.

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The Maximum Mortgage Tax Deduction Benefit Depends On Income is a FS original post. The figures are changing yearly. But overall, the higher your marginal income tax rate and income, the greater the mortgage tax deduction benefit. However, after about a $200,000 individual income, the mortgage tax deduction benefit begins to phase out due to AMT.