The Tax Deductibility of Mortgage Insurance Receives Another Stay of Execution

Tax Deductible MI ExtraOn December 18, 2015, as part of the Protecting Americans from Tax Hikes (PATH) Act of 2015, the President signed legislation that retroactively renews the tax deductibility of mortgage insurance (MI) premiums for qualified borrowers through 2016.

The deductibility is effective for purchase and refinance transactions closed after December 31, 2014. MI premiums paid or accrued after December 31, 2014 and through December 31, 2016 may qualify for tax deductibility on a borrower’s federal tax returns as follows:

  • Borrowers with adjusted gross income below $100,000 ($50,000 for a married individual filing a separate return) may deduct 100% of their allowable MI premiums
  • For borrowers with adjusted gross incomes from $100,000.01 to $110,000, deductions are phased out ratably in 10% increments for each additional $1,000 ($500 for a married individual filing a separate return) of adjusted household income*

Until 2007, mortgage insurance premiums were not tax-deductible on your income tax return. As a result of the Tax Relief and Health Care Act of 2006, for tax years 2007 through 2013, homeowners were able to deduct as an itemized deduction the cost of premiums for qualified mortgage insurance on a qualified home. The Tax Increase Prevention Act of 2014 retroactively extended the tax deductibility of mortgage insurance through December 31, 2014.

Qualified mortgage insurance is mortgage insurance provided by the Department of Veterans Affairs (VA), the Federal Housing Administration (FHA), the Rural Housing Service (USDA), and private mortgage insurance, as defined by Section 2 of the Homeowners Protection Act of 1998, as in effect on December 20, 2006. Mortgage insurance provided by the Department of Veteran Affairs is commonly referred to as a funding fee. Mortgage insurance provided by the Rural Housing Service is commonly referred to as a guarantee fee.

Prepaid premiums for mortgage insurance other than that provided by the VA or RHS are not fully deductible in the initial year, but must be amortized over the period to which they apply. The unamortized balance is not deductible if the mortgage is paid off before the end of its term. Allocate the prepaid premium ratably over the shorter of:

  • The stated term of the mortgage (e.g., 15, 20, 30 years), or
  • 84 months, beginning with the month in which the insurance was obtained

tax-refund-350For monthly mortgage insurance premiums, such as FHA mutual mortgage insurance and private mortgage insurance common with Conventional mortgages, any amounts paid during a tax year are fully deductible in that year, subject to the income limitations outlined above.

The premiums are deductible as mortgage interest. To be deductible the premiums must have been paid in connection with the acquisition debt on a purchase transaction that closed after December 31, 2006. Acquisition debt is a loan used to acquire, construct, or substantially improve a qualified home**. For example, if you purchase a home for $300,000 and put 5% down ($15,000), the $285,000 ($300,000 – $15,000) principal loan is considered acquisition debt.

It’s important to note that acquisition debt decreases anytime a homeowner makes principal payments toward the balance of the mortgage. Continuing our example, if you paid $25,000 toward the principal balance of your mortgage, whether through monthly principal payments, lump sum principal payments, or a combination of the two, your acquisition debt would decrease to $260,000 ($285,000 – $25,000), and ultimately to zero as additional principal payments are applied over the term of the loan.

Mortgage insurance premiums are still tax deductible for a refinance transaction, but only for the portion of the principal balance attributable to acquisition debt. Taking our example one step further, if you were to refinance and your new mortgage amount became $285,000, the acquisition debt is $260,000 and only the mortgage insurance attributable to that amount remains tax deductible.

Since this is another temporary extension, albeit a two year extension this time, we will find ourselves in the same boat again as we approach the end of 2016! If Congress allows this measure to expire mortgage insurance will revert back to being non-tax-deductible. If that happens, mortgage insurance will still serve a vital purpose in the path to homeownership, but it will no longer receive favorable tax treatment.

If you are currently paying mortgage insurance premiums and would like to discover ways to eliminate them contact us to discuss your specific circumstances.

*If income greater than $100,000.01 is not a multiple of $1,000 you must round up to the next $1,000 (e.g., $101,125 = $102,000)

**A qualified home can be both a primary and a secondary residence and there are restrictions on the type of properties that qualify.

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