Can you deduct mortgage interest on a second home?

Will you be able to deduct second mortgage interest on your taxes if you have taken out a second home loan? It’s a good question – and the answer will no doubt affect your annual financial planning calculations. The answer is yes, generally you can. However, be advised that there are certain terms and conditions you’ll want to know to determine if you’re eligible to enjoy such tax deductions, as outlined below.

Is mortgage interest deductible on a second home?

The short answer is yes. Fortunately for taxpayers, you can still deduct second mortgage interest, but only under certain terms. Factors affecting your ability to qualify can include the type and current amount of mortgage debt you have and the date your loan was originated. There are other factors that can affect whether or not you qualify for interest tax deductions as well. However, the good news is that the interest charged on mortgages for a second home and home equity loans is generally still deductible.

What is a second mortgage?

A second mortgage, which allows you to borrow a lump sum of cash as needed, is a loan or line of credit that you choose to take out against the equity in your home. It differs from a mortgage refinance, which replaces your old home loan with a new home loan and allows you to access home equity without requiring you to make a second monthly payment.

Understanding mortgage interest and mortgage debt

The Internal Revenue Service (IRS) uses the terms “mortgage interest” and “mortgage debt” in different ways. In simple terms, mortgage debt defines monies owed on the loan that you have taken out to purchase a single-family home, apartment, condo, townhouse or other type of real estate property.

By way of contrast, mortgage interest (expressed as a fixed or variable percentage rate of a total loan amount) describes the amount of interest that a lender charges you in fees for a loan that you use to purchase a piece of property.

Note that the two most common types of debts that you might expect to encounter as part of a second mortgage are:

• Home acquisition: Debt associated with the purchase of another property. Homeowners can deduct the interest on a second mortgage associated with home acquisition debt so long as they secure this debt with the second home.
• Home equity: Home equity mortgage debt is associated with a loan type in which a borrower leverages the equity of their home as a form of collateral. Homeowners can deduct the interest on a second mortgage related to home equity debt only if the loan was used to acquire, build, or substantially improve a main or second home.

Qualifications for second home interest deductions

Homeowners will need to meet specific qualifications and steer clear of select restrictions if they want to be eligible to deduct interest on second mortgages in the current tax year. These guidelines are as follows.

Secured by your home

Per IRS findings, only second mortgage interest paid on acquisition indebtedness (i.e., a loan used to acquire, build, or substantially improve a main or second home) is deductible. This debt must apply to the specific home you have used to secure the second mortgage if you want any sums to become eligible for interest deductions.

Below the total mortgage debt limit

Mortgage interest is currently tax deductible up to the total amount of interest paid in any given year on the first $750,000 of your mortgage, or $375,000 if married filing separately. (Or $1 million for those who purchased homes before 2018 – or $500,000 if married filing separately.)

For tax purposes, second mortgages carry mortgage interest because they use your house as collateral. Your current debt load will impact whether or not you can include second mortgage interest alongside your other homeowner tax deductions.

Grandfathered in with prior tax treatments

Did your second mortgage originate on or before December 15, 2017? If so, you can enjoy the benefit of grandfathered debt. The Tax Cuts and Jobs Act (TCJA) of 2017 lowered the mortgage deduction limit and limited how much you can deduct from your taxable income.

In other words, you’ll find yourself grandfathered into previous historical tax guidelines – aka able to deduct interest on up to $1 million ($500,000 if married filing separately) of mortgage debt. (As opposed to current guidelines, which limit deductible interest to sums paid on up to $750,000 of mortgage interest payments, or $375,000 if married filing separately.)

Be aware that you can’t double dip. You can’t take a grandfathered debt of more than $750,000 but less than $1 million and combine it with a new mortgage that brings you up to the $1 million cap. (See below examples for illustrations.) Under this circumstance, you’d be limited to deducting second mortgage interest on only the amount of interest that is associated with your original grandfathered debt.

Used to pay for home improvements

As mentioned previously, the TCJA now requires that home equity loans and home equity lines of credit must be used for home improvements (or home acquisitions). If used for other purposes, the interest paid on the loan may not be deductible on the homeowner’s taxes.

Can you deduct second mortgage interest on a rental property?

If you’re using this second home as a rental property, the IRS has separate terms for deducting that mortgage interest. The IRS must consider this property a qualified home. To qualify, you must live in that second home for more than 14 days or 10% of the number of days during the year the home is rented at a fair rental, whichever is longer.

If you don’t fulfill this requirement, the IRS will consider the second home a rental property. The result is that you will not be eligible to deduct the second mortgage interest on your taxes. However, you could take advantage of the tax deductions available for a rental or investment property.

A tax professional can help you understand how a second mortgage interest deduction works for your situation.

Examples of deducting second mortgage interest

Let’s say you purchase a primary residence for $500,000, then acquire a new property as an investment home for $250,000. You are eligible to take second mortgage interest tax deductions (and primary mortgage interest tax deductions) paid on the total of the amounts borrowed ($750,000).

Now, let’s say a married couple purchased a piece of property for $850,000 in 2015, and then took out a home equity line of credit for $50,000 in 2020. They are only eligible to deduct interest monies paid on up to $850,000 (the amount of the original mortgage). The original grandfathered debt qualifies for a second mortgage interest deduction under historical terms. But the home equity loan does not because you can’t combine it with this grandfathered debt to get around the current $750,000 IRS cap.

Reporting second home interest deductions on your taxes

Homeowners wishing to capitalize on second mortgage interest tax deductions will need to keep documentation about any related transactions. They must also submit a 1098 Form (Mortgage Interest Statement) from their lender with a Form 1040, Schedule A for itemized deductions. A qualified tax accountant can help you compile and get this paperwork in order.

The bottom line: Interest on a second home can be deducted

Second mortgage interest is tax deductible in certain circumstances, provided you meet minimum IRS qualifications and follow current federal tax guidelines. This means that only a certain portion of expenses associated with your outstanding debts may be deductible. However, monies you paid in second mortgage interest may help you recognize significant tax savings.

Ready to unlock the tax benefits of owning a second home? Start the mortgage process today!