If you're still paying off your mortgage, the IRS offers a popular tax deduction that may significantly reduce your taxable income. Known as the "mortgage interest deduction," it allows you to reduce your gross income by the total amount of interest that you paid on your mortgage during the tax year. Unfortunately, it can't be applied in conjunction with the "standard deduction" that most non-homeowners take. As an itemized deduction, it must either be used in conjunction with other itemized deductions or not be used at all.
For most taxpayers, the "standard deduction" is set at about $11,000. If the total value of your itemized deductions is greater than this amount, you'll want to forgo the standard deduction and claim every other deduction for which you're eligible. Your eligible mortgage interest may represent the single largest deduction that you're able to claim.
When you calculate the exact amount of mortgage interest that you're eligible to deduct, avoid claiming any principal repayments that you made over the course of the year. This technically constitutes tax fraud. If you're still repaying the interest on an interest-only mortgage, you won't have this problem. To determine the value of your deduction, you'll merely need to add up the total number of payments that you made over the course of the year.
However, most mortgage payments are comprised of a combination of principal and interest. To separate the two, you'll need to use your mortgage's interest rate to calculate the interest value of each payment. For instance, a mortgage that features an annual interest rate of 4 percent and requires a total monthly payment of $499.20 would carry a monthly interest charge of $19.20. Once you've found your monthly interest charge, multiply it by 12 to find your annual interest charge.
The exact amount of money that you save by claiming your mortgage interest as a tax deduction will depend upon two factors: the rate at which your income is taxed and the amount by which the value of your itemized deductions exceeds that of the standard deduction. To determine your savings, determine the difference between the value of your itemized deductions and that of the standard deduction. Multiply this difference by your marginal tax rate. If your itemized deductions exceed the standard deduction by $2,000 and your income is taxed at 25 percent, you'll increase the size of your expected tax refund by $500 using itemized deductions.