What is this TCJA ?

The Tax Cuts and Jobs Act (TCJA) of 2017 has had a significant impact on the decision to buy a house to live in or rent it. This law includes several changes that could affect the financial benefits of owning a home, and it’s important to understand how they could affect your decision in pursuit of Financial Independence.

Mortgage interest deduction with the TCJA

For those who do itemize their deductions, the TCJA has made it less beneficial to claim the mortgage interest deduction. This deduction allows taxpayers to deduct the interest paid on their mortgage from their taxable income, but the TCJA has made it less attractive by limiting the deductibility of state and local taxes, capping the mortgage balance for which interest can be deducted, and eliminating the deduction for home equity loan interest.

Prior to the TCJA, homeowners could claim a mortgage interest tax deduction on mortgage debt up to $1 million, as well as on the interest paid on home equity loans up to $100,000. This means that if a homeowner had a mortgage balance of $1 million and paid $45,000 in interest in a year, they could claim a tax deduction of $45,000 on their income taxes.

Under the TCJA, the mortgage interest tax deduction is limited to mortgage debt of up to $750,000, and the deduction for home equity loan interest is eliminated entirely. This means that if a homeowner has a mortgage balance of $1 million and pays $45,000 in interest in a year, they can now only claim a tax deduction of $33,750. The remaining $12,500 in interest is no longer tax-deductible.

 

Standard deduction is doubled

Another significant change brought about by the TCJA is the increase in the standard deduction. The standard deduction is a set amount that can be subtracted from your taxable income, and it has been nearly doubled under the new law. This means that many taxpayers who used to itemize their deductions may no longer need to do so.

Under the previous tax law, taxpayers could choose to take the standard deduction or itemize their deductions, whichever provided them with a greater tax benefit. Many taxpayers chose to itemize their deductions, including the mortgage interest tax deduction, if their total itemized deductions exceeded the standard deduction. For example, the standard deduction for married couples filing jointly increased from $12,700 to $24,000.

 

Mortgage deduction rendered pointless

With the significantly increased the standard deduction, it is more likely that taxpayers will choose to take the standard deduction rather than itemizing their deductions. As a result, fewer taxpayers are likely to itemize their deductions, including the mortgage interest tax deduction.

For example, consider a married couple who has a mortgage with a balance of $500,000 at 4% and pays $20,000 in mortgage interest each year. Prior to the TCJA, the couple could have claimed the mortgage interest tax deduction by itemizing their deductions, reducing their taxable income by $20,000. Under the TCJA, however, the couple may choose to take the standard deduction of $24,000 rather than itemizing their deductions. In this case, the couple would not be able to claim the mortgage interest tax deduction, and their taxable income would not be reduced by the interest they paid on their mortgage.

 

So what’s the verdict?

The Tax Cuts and Jobs Act has significantly reduced the value of the mortgage interest deduction for many homeowners. The increase in the standard deduction and the cap on the amount of mortgage debt that qualifies for the deduction means that fewer homeowners are able to take advantage of this tax break. As a result, the mortgage interest deduction is no longer as attractive or beneficial for many homeowners as it once was. For many people pursuing FIRE, that takes away one of the dear advantages of buying vs renting.

The mortgage interest tax deduction is now as useless as spending time polishing an already shining diamond.