Understanding the mortgage interest deduction for US expats

What is the mortgage interest deduction?

Are you a US expat who's lucky enough to own a home in the US?

Well, you might be even luckier than you think, because the mortgage interest deduction could save you a bunch of money on your US taxes.

Basically, this deduction lets you subtract the interest you pay on your US mortgage from your taxable income, which means you could end up with some serious tax savings.

The great news is that the mortgage interest deduction is available to all US taxpayers who itemize their deductions on their federal income tax return.

But, it's especially valuable for US expats who have to pay US taxes on their income from all over the world, because it can help lower their US tax bill.

How the mortgage interest deduction works

So, how exactly does the mortgage interest deduction work?

When you take out a mortgage to buy a home, you'll have to pay interest on that loan. This interest can add up to a lot of money over time.

However, with the mortgage interest deduction, you can deduct a portion of that interest from your taxable income.

Here's an example to help illustrate how it works.

Let's say you have a mortgage with an interest rate of 4%. In the first year of your mortgage, you pay $8,000 in interest.

If you're in the 22% tax bracket, you can deduct $1,760 from your taxable income ($8,000 x 0.22 = $1,760). This means you'll pay $1,760 less in taxes that year.

What qualifies as deductible mortgage interest?

Generally, you can deduct the interest you pay on a loan secured by your main home or a second home, such as a vacation home. The loan must be used to buy, build, or improve the home.

In addition to the interest on your main mortgage, you can also deduct the interest on a home equity loan or line of credit if the loan was used to buy, build, or improve your home.

However, if the loan was used for other purposes, such as to pay off credit card debt or to finance a car, the interest may not be deductible.

NOTE! It's important to keep in mind that there are limits to the amount of mortgage interest you can deduct, and not all homeowners will be eligible for the deduction.

What mortgage costs are not deductible?

As a US expat, if you're planning to claim the mortgage interest deduction on your US taxes, it's important to know that (NB) not all mortgage costs are deductible.

In fact, only the interest you pay on your mortgage is deductible, and there are several costs that are not deductible under the mortgage interest deduction.

Some of the mortgage costs that are not deductible under this deduction include:

• mortgage insurance premiums,
• homeowners insurance,
• property taxes.

However, there are a few special circumstances where some of these costs might be deductible.

Are there special circumstances?

While mortgage insurance premiums, homeowners insurance, and property taxes are generally not deductible, there are a few special circumstances where you may be able to deduct some of these costs:

1. For example, if you pay mortgage insurance premiums as part of your mortgage payment and your income is below a certain level, you may be able to deduct those premiums as mortgage interest.
2. Similarly, if you use a portion of your home for business purposes, you may be able to deduct a portion of your property taxes and homeowners insurance.

NB! It's important to review IRS guidelines carefully or - to consult with a tax pro to determine if you qualify for these special circumstances and can deduct any of these costs on your US taxes.

Is there a limit to mortgage interest tax deduction?

Yes, there is a limit to how much mortgage interest you can deduct. The limit depends on when you took out your mortgage and how much it's for.

For mortgages taken out after December 15, 2017, you can only deduct interest on the first $750,000 of your mortgage debt ($375,000 if you're married filing separately).

If your mortgage was taken out before December 15, 2017, you can deduct interest on the first $1 million of your mortgage debt ($500,000 if you're married filing separately).

NB! These limits only apply to mortgages on your primary residence or a second home. If you have a mortgage on a rental property or other investment property, the interest you pay is generally fully deductible as a business expense.

How to claim the mortgage interest deduction in 5 steps

If you're planning to claim the mortgage interest deduction, it's essential to know how to do it right.

Here's a step-by-step guide to help you claim it with ease:

1. Check if you are eligible

To claim the mortgage interest deduction, you need to itemize your deductions on your federal income tax return. It's not for everyone, so make sure you meet the qualifications.

2. Get all the necessary paperwork

Gather all the relevant paperwork, including Form 1098, which is provided by your mortgage lender.

3. Calculate your deductible mortgage interest

Use Form 1098 to calculate the amount of mortgage interest you paid during the tax year.

4. Fill out Schedule A

You need to fill out Schedule A if you're itemizing your deductions, which is where you'll claim your mortgage interest deduction.

5. File your tax return

Include Schedule A with your federal income tax return when you file.

Pro tip. Remember to keep accurate records of your mortgage interest payments and other deductions, so you can quickly and easily claim them at tax time. By claiming the mortgage interest deduction correctly, you can reduce your taxable income, which will ultimately lower your tax bill.

Mortgage interest deduction examples

Let's take a look at a couple of examples to see how the mortgage interest deduction works in practice.

Example 1:

John and Mary are US expats living in the UK, and they bought a home in the US for $300,000.

They have a 30-year fixed-rate mortgage with an interest rate of 4%. In the first year, they paid $12,000 in mortgage interest. Additionally, they paid $2,000 in property taxes and $800 in homeowners insurance.

To claim the mortgage interest deduction, John and Mary need to itemize their deductions on their federal income tax return. They can use Form 1098 to calculate the deductible amount of their mortgage interest, which is $12,000 for the year.

Unfortunately, their property taxes and homeowners insurance are not deductible under the mortgage interest deduction.

Therefore, they cannot claim these costs as deductions.

Example 2:

Tom is a US expat living in Japan who purchased a home in the US for $500,000 and took out a 30-year fixed-rate mortgage with an interest rate of 3.5%.

In the first year, he paid $17,500 in mortgage interest. Tom also paid $4,000 in mortgage insurance premiums and $2,000 in property taxes.

Since Tom's income is below a certain level, he can deduct the mortgage insurance premiums as mortgage interest. Using Form 1098, Tom calculates that he paid $21,500 in deductible mortgage interest for the year. He can also deduct a portion of his property taxes as he uses a part of his home for business purposes.

Pro tip. These are just examples, and your situation may be different. It's always a good idea to consult with a tax professional to determine how the mortgage interest deduction applies to your specific situation and how much you can save.

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