How To Make Your Canadian Mortgage Interest Tax Deductible
Here in Canada, we dont get to write off home mortgage interest on our personal residences they do in the United States without formal planning. Many Canadians have to pay every dollar of interest with after-tax dollars. The name of the game here is tax savings and wealth creation through strategic conservative leverage wealth strategy.
But there is a way around that for many Canadian homeowners that was formerly called the Smith Manoeuvre. This popular tax planning tactic is named by Fraser Smith, a well-known Canadian author of a popular personal finance book, The Smith Manoeuvre. While the book is somewhat antiquated on the mortgage side now much of the core fundamentals still hold true. In the interest of full disclosure, I met with the late Fraser Smith in 2003 to discuss how to support Canadians at a broader level with this strategy.
Heres how it works
Canada does not allow you to deduct personal mortgage interest. But it does allow you to deduct interest on loans you make for the purposes of investment, as long as you do it within a non-registered account and meet CRA guidelines for deductibility which can be found on CRAs website in a simplified version here:
But how do you turn your personal home loan into an investment loan? Well, you cant do it all at once. But you can do it a little at a time, using a tool called a re-advanceable mortgage.
Heres the intended result:
Whats Deductible And What Isnt
There are several types of home loans eligible for the mortgage interest tax deduction. But there are some restrictions.
Types of Loans that May Let You Claim the Mortgage Interest Tax Deduction
- Traditional mortgage
- Home equity loan
The chief requirement for being able to deduct interest payments is that the loan was secured by your primary or secondary home for which its being used to buy, build or improve. You cannot claim a deduction on personal loans or loans secured by a third, fourth or other home.
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Benefits Go Mainly To Higher
Little of the deductions benefits go to households that have difficulty affording a home. Data from the Census Bureaus American Housing Survey show that in 2011, 10.5 million homeowners faced what HUD calls severe housing cost burdens, meaning they paid more than half of their income for housing. Some 90 percent of those homeowners had incomes below $50,000, yet JCT estimates for 2012 show that homeowners with incomes below that level received only 3 percent of the benefits from the mortgage interest deduction.
At the same time, 77 percent of the benefits from the mortgage interest deduction went to homeowners with incomes above $100,000, almost none of whom face severe housing cost burdens. Some 35 percent of the benefits went to homeowners with incomes above $200,000 taxpayers in this income group who claimed the deduction received an average subsidy of about $5,000.
The deductions benefits are concentrated among higher-income households for several reasons.
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Mortgage Interest Deduction Limit
The mortgage interest deduction limit was signed in 2017, when the Tax Cuts and Jobs Act, or TCJA, lowered the mortgage deduction limit, altering individual income tax, and placing a limit on the amount you may deduct from your home equity loan debt.
Prior to the Tax Cuts and Jobs Act, the limit for mortgage interest deduction was $1 million. In 2022, however, the limit dropped to $750,000, meaning that this tax year, married couples filing together and single filers can deduct the interest as high as $750,000. Married taxpayers filing separately can deduct has high as $375,000 each.
The exceptions to the mortgage interest deduction limit include:
– Mortgages taken out prior to October 13, 1987, are called grandfathered debt and are not limited, meaning all of the interest paid is deductible
– Homes bought after October 13, 1987, and prior to December 16, 2017, are eligible for the previous $1 million limit. If married and filing separately, that number becomes $500,000 each and
– Homes sold prior to April 1, 2018, are still eligible for the $1 million limitif there was a binding contract signed prior to December 15, 2017, that closed prior to January 1, 2018, and the house was bought prior to April 1, 2018.
Are Closing Costs Tax Deductible In 2021
Can you deduct these closing costs on your federal income taxes? In most cases, the answer is no. The only mortgage closing costs you can claim on your tax return for the tax year in which you buy a home are any points you pay to reduce your interest rate and the real estate taxes you might pay upfront.
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Miracle Cure: The Mortgage Interest Deduction
Thanks to a law passed all the way back in 1913 , most of the interest paid onhome mortgage loans is eligible for the mortgage interest deduction. Its not as complicated as it sounds: any income you spend can be subtracted from your total taxable income, which in turn lowers the amount you pay in income taxes.
So, lets say for example that you make $75,000 this year and spend $10,000 of that on mortgage interestthats about the amount you would spend in the first year of a $250,000 mortgage with a 4% interest rate. By taking the mortgage interest deduction, your taxable income would fall to $65,000. Assuming your marginal tax rate is 25%, you could save $2,500 in taxes, just like that!
Even with a more modest $150,000 mortgage, you could still save on the order of $1,500 in income taxes taking this deduction in your first year of paying off the mortgage. Thats a lot of money, but keep in mind that your yearly savings from the mortgage interest deduction will fall over time. This is a natural result of the amortization of your loan. As you pay off your mortgage, a smaller portion of each payment goes toward interest, so theres less interest to deduct.
Recent Changes To The Mortgage Interest Deduction
The TCJA reduced the amount of principal available for the mortgage interest deduction from $1 million to $750,000. The new law also changed the treatment of home equity loans. Prior to the TCJA, interest on up to $100,000 of home equity loans was deductible in addition to interest paid on up to $1 million in principal and could be used for expenses like credit card debt or tuition. After the TCJA, home equity loans are now included within the mortgages principal limit, and interest is only deductible if used to build or improve a qualifying residence.
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Complete Guide To Claiming Your Mortgage Interest Deduction
The mortgage interest deduction reduces your taxable income and your tax bill. But youll have to itemize your deductions to claim it.
Edited byChris JenningsUpdated October 12, 2021
Our goal is to give you the tools and confidence you need to improve your finances. Although we receive compensation from our partner lenders, whom we will always identify, all opinions are our own. Credible Operations, Inc. NMLS # 1681276, is referred to here as Credible.
The IRS mortgage interest tax deduction can reduce your taxable income by allowing you to write off the interest you pay on your home loan during the tax year:
- If you took out your mortgage before Dec. 16, 2017 and used it to buy, build, or improve your home, youre able to deduct the mortgage interest you paid on the first $1 million of your mortgage .
- If you took out your mortgage after Dec. 15, 2017 and used it to buy, build, or improve your home, youre able to deduct the interest paid on the first $750,000 of your mortgage .
Heres what you should know about qualifying for the mortgage interest deduction and how to deduct it:
Mortgage Interest Deduction Is Among The Largest Tax Subsidies
Homeowners can currently deduct their interest payments on home mortgage balances up to $1 million from their taxable income. They also can deduct interest on home equity loans of up to $100,000. Within these caps, taxpayers can claim deductions on up to two homes.
The mortgage interest deduction is part of a group of deductions known as itemized deductions, which also include deductions for charitable giving and state and local taxes. Taxpayers can either itemize their deductions or take the standard deduction . Only about one-third of filers itemize their deductions.
The mortgage interest deduction is considered a tax expenditure or tax subsidy because it provides a benefit to a particular group of taxpayers it is the most costly itemized deduction and among the largest tax expenditures. The Joint Committee on Taxation estimated in January 2013 that it will reduce revenues by $70 billion in 2013 and by $379 billion over the five years from 2013 to 2017.
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Mortgage Interest And The Standard Deduction
You cannot deduct mortgage interest in addition to taking the standard deduction. To take the mortgage interest deduction, youâll need to itemize. Itemizing only makes sense if your itemized deductions total more than the standard deduction, which is between $12,200 and $24,400 for the 2019 tax year, depending on your filing status.
Whatever tax savings you get from itemizing your mortgage interest are as a result of not only mortgage interest you pay, but also to your charitable donations, property taxes, mortgage insurance, state income tax or sales tax, and anything else you itemize.
What might your savings from itemizing look like under various scenarios? The savings vary a lot based on how much mortgage interest you pay and your filing status, as well as how much state tax you pay and how much your other itemized deductions add up to.
For example, if youâre married filing jointly and you have $19,000 in itemized deductions, including $5,000 of mortgage interest, youâre much better off taking the $24,400 standard deduction. In this case, if you itemize your mortgage interest deduction ends up being zero because it doesnât reach the standard deduction limit. Yet, you could be single with only $17,000 in itemized deductions, including $5,000 in mortgage interest, and save more than $1,000 by itemizing because the standard deduction for single filers is $12,200..
Interest On The Mortgage For A Second Home
You can use this tax deduction on a mortgage for a home that is not your primary residence as long as the second home is listed as collateral for that mortgage. If you rent out your second home, there is another caveat. You must live in the home for more than 14 days or more than 10% of the days you rent it out whichever is longer. If you have more than one second home, you can only deduct the interest for one.
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How To Claim A Mortgage Interest Deduction
Sitting down to fill out your income tax return and claim your deduction can be a daunting task. But preparation is key. As long as you have all the documents you need, its just a matter of following the instructions in the tax form booklets or online.
Here are the steps you should take so that youre prepared to claim:
These are good steps to follow, but please remember to always consult a tax professional on tax matters.
The Home Mortgage Interest Deduction And Effective Marginal Tax Rates
The impact the income tax has on housing can be summarized by measuring the effective marginal tax rate on housing. An EMTR is a summary measure, expressed as a single percentage, that estimates how a tax system reduces the return to, and thus the incentive to invest in, a new asset, like a house.
An EMTR can be thought of as a tax wedge equal to an investments pretax rate of return minus its after-tax rate of return, divided by its pretax rate of return. For instance, if a tax takes 3 percentage points of a 9 percent pretax rate of return, the EMTR on the asset would be 33.3 percent /.09). Assuming that the investment needed a 6 percent after-tax return in order to break even and satisfy investors, the investments rate of return needed to increase by 50 percent to cover the tax.
An EMTR of zero means that taxes do not impact marginal investment decisions, while a positive EMTR means the tax code discourages a marginal investment. Large differences in EMTRs among assets is a sign of economic inefficiency, because the tax code encourages investment in capital with lower EMTRs compared to capital with higher EMTRs.
Source: Congressional Budget Office, Budget and Economic Data, Tax Parameters and Effective Marginal Tax Rates, EMTR on Capital, Apr. 2018, .
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Is There A Limit On Mortgage Interest Deduction In 2021
With the tax reform bill signed in December 2017, many people are wondering what changes come to other deductions such as mortgage interest and charitable contributions. For starters, interest on mortgages will be deductible up to $750,000 for newly purchased homes.
If you are considering a move, this is a good time to do it since the rates of home loans have dropped significantly. On the other hand, you will no longer be able to deduct any charitable donations on your return after cash gifts of over $15,000 per year. If the interest rates are going up, homeowners may need to take actions to reduce their bills.
The most common one is to pay down a mortgage loan. If homeowners decide to do this, they may be entitled to take advantage of a tax deduction that could help them save as much as $3,000 in taxes on interest repayment.
The US tax law is designed in such a way that the taxpayer is able to determine what deductions they qualify for and if theyre claiming more than their available deduction limit, they will be charged with underpayment penalties. The new tax code, which has not been officially passed yet, will extend the mortgage interest deduction cap on interest being deductible until 2021.
This means that in 2020, taxpayers can only claim up to $750,000 worth of home mortgage interest on one house. The Republicans and Democrats in Congress are trying to come to an agreement on what will happen with the mortgage interest deduction when the tax reform is implemented.
How To Claim Your Deduction
Eligible homeowners can claim the mortgage interest tax deduction on Schedule A of their annual tax returns. Schedule A accompanies Form 1040 or 1040-SR .
To find out how much mortgage interest you paid during the year, look at your mortgage interest statement, IRS Form 1098. Your lender will send one copy of this form to you and one copy to the IRS. Youâll receive it in January or February each year.
IRS Publication 936, updated annually, contains all the information most taxpayers will need to determine their eligibility for the mortgage interest tax deduction. Taxpayers with complex situations may need to ask a Certified Public Accountant for help.
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Mortgage Interest Deduction Basics
If you claim the mortgage interest deduction on Schedule A of Form 1040, you will need to itemize rather than take the standard deduction when you file your taxes.
As noted above, unfortunately, investors can only take this tax deduction if they use their second home as a rental property. If you have a standard investment property, you can still deduct your interest payment as a business expense if you file a Schedule E at the end of the tax year.
The new tax law has now lowered that $1 million limit to $750,000, but only for new mortgages taken out after December 14, 2017. For mortgage loans existing on that date, the limit is still $1 million. And interest on these “grandfathered” mortgages will remain deductible as long as the homeowner keeps the loan. Such loans can even be refinanced with the deduction retained, so long as the original term of the loan and the balance owed on the date of refinancing is not increased.
What Is A Mortgage Interest Deduction
The mortgage interest deduction is a common itemized deduction that allows homeowners to deduct the interest they pay on any loan used to build, purchase, or make improvements upon their residence, from taxable income. The mortgage interest deduction can also be taken on loans for second homes and vacation residences with certain limitations.
The amount of deductible mortgage interest is reported each year by the mortgage company on Form 1098. This deduction is offered as an incentive for homeowners.
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