Tax Benefits of Assuming a Low-Interest Mortgage
While the most significant savings from a low-rate mortgage come from paying less interest, it’s crucial to understand how your mortgage choice impacts your tax situation.
Key Takeaways
- The primary tax benefit associated with a mortgage is the Mortgage Interest Deduction (MID), which allows some homeowners to deduct their interest payments from their taxable income.
- A low-rate mortgage generates significantly less interest, and therefore a much smaller potential tax deduction compared to a high-rate loan.
- However, with the high standard deduction amounts, many homeowners no longer itemize, making the value of the MID less impactful for them than the direct cash savings from a lower rate.
- For investors, an assumable mortgage’s primary tax advantage is that the lower debt cost maximizes cash flow, while the property’s depreciation deduction (based on purchase price) remains the same, creating a powerful tax shield.
- Upon selling, the capital gains calculation is based on the sale price minus the cost basis, which is unaffected by the type of mortgage used.
Assumptions & Inputs
- Loan Scenarios: Based on the 2.75% and 7.0% loan comparisons from previous articles.
- Tax Law Basis: Based on U.S. Federal tax law and IRS publications as of the 2024 tax year, for illustrative purposes in 2025.
- Filing Status Example: Married Filing Jointly.
- Standard Deduction (2024): $29,200*.
- Note: Tax laws are complex and subject to change. This article is for educational purposes only. It is not tax advice. Consult a qualified tax professional.
What Are the Tax Benefits of a Mortgage?
When people talk about the tax benefits of homeownership, they are almost always referring to the Mortgage Interest Deduction (MID). As defined by the Internal Revenue Service (IRS) in Publication 936, the MID allows a homeowner who itemizes their deductions to deduct the interest paid on a mortgage used to buy, build, or substantially improve their primary or secondary residence.
For decades, this was a cornerstone of housing policy and a significant financial benefit for homeowners. However, recent changes in tax law, particularly the large increase in the standard deduction, have changed the calculation for many families.
It is absolutely critical to understand that the direct, guaranteed cash savings from a lower interest rate are separate from the potential, conditional savings from a tax deduction. Let’s be crystal clear: you should never choose a higher-rate loan just to get a bigger tax deduction. That’s like spending a dollar to save thirty cents.
Why It Matters: Separating Myth from Reality
There’s a persistent myth in real estate that a big mortgage payment is good because it gives you a big tax write-off. This is a fundamental misunderstanding of how deductions work. A deduction doesn’t give you a dollar-for-dollar credit; it simply reduces your taxable income. The actual cash value of the deduction depends on your marginal tax bracket.
This article matters because it will help you:
- Quantify the true value of the MID: We’ll compare the deduction for a 2.75% loan vs. a 7.0% loan.
- Understand the Standard vs. Itemized Deduction: We’ll show why the MID may not even apply to many homeowners today.
- Analyze the Investor Perspective: We’ll explore the real tax benefit for investors: depreciation.
The Math: A Head-to-Head Tax Deduction Comparison
Let’s analyze the potential mortgage interest deduction for a homeowner in the first full year of owning their home.
Inputs & Formulas
- Annual Interest Paid (Year 1):
- 7.0% Loan: $15,257*
- 2.75% Loan: $5,942*
- Other Itemized Deductions (Example): State and Local Taxes (SALT), capped at $10,000*.
- Standard Deduction (Married Filing Jointly): $29,200*
Example Walkthrough: The Itemization Decision
Scenario 1: The Homeowner with the 7.0% Loan
- Calculate Potential Itemized Deductions:
- Mortgage Interest: $15,257*
- State and Local Taxes (SALT): +$10,000*
- Total Itemized Deductions: $25,257*
- Compare to Standard Deduction:
- Their total itemized deductions ($25,257*) are less than the standard deduction ($29,200*).
- Conclusion: This homeowner would not itemize. They would take the higher standard deduction. In this common scenario, the $15,257* in mortgage interest they paid provides them with zero additional tax benefit.
Scenario 2: The Homeowner with the 2.75% Loan
- Calculate Potential Itemized Deductions:
- Mortgage Interest: $5,942*
- State and Local Taxes (SALT): +$10,000*
- Total Itemized Deductions: $15,942*
- Compare to Standard Deduction:
- Their total itemized deductions ($15,942*) are also far less than the standard deduction ($29,200*).
- Conclusion: This homeowner would also take the standard deduction.
In both cases, the direct cash savings are what matter. The 2.75% loan holder saved $9,315* in actual interest payments ($15,257* – $5,942*) in the first year. That is real money in their pocket, whereas the “tax benefit” of the higher interest was non-existent for the 7.0% loan holder.
When Does the MID Actually Help?
A homeowner would only receive a tax benefit from their mortgage interest if their total itemized deductions exceed the standard deduction. This typically only happens for high-income earners who also have very large mortgages, significant state and local taxes (in states with high income/property tax), and substantial charitable contributions.
The Real Tax Benefit for Investors: Depreciation
While the MID is less impactful for homeowners, the tax story for real estate investors is completely different and far more beneficial. The primary tax advantage for an investor is depreciation.
What is Depreciation?
As defined by the IRS, depreciation is an annual income tax deduction that allows you to recover the cost or other basis of certain property over the time you use the property. For residential rental property, you can depreciate the value of the building (not the land) over 27.5 years. This is a “phantom” deduction—you get to deduct it from your income even though you didn’t spend any actual cash on it that year.
- How it Works: Let’s say our $320,000* Kingwood property has a building value of $250,000*.
- Annual Depreciation Deduction: $250,000* / 27.5 years = $9,091*.
- The Investor’s Win: The investor gets to deduct $9,091* from their rental income each year, which can significantly reduce or even eliminate their taxable income from the property.
The type of mortgage you have has no impact on the amount of depreciation you can claim. This creates a powerful synergy for an investor with an assumable loan:
- The low 2.75% interest rate maximizes their actual cash flow.
- The large depreciation deduction minimizes their taxable income.
This combination of high cash flow and low taxes is the holy grail for a buy-and-hold real estate investor.
Capital Gains on Sale
When you sell your home, the tax implications are related to capital gains.
- For a Primary Residence: The tax code (specifically Section 121) allows a homeowner to exclude up to $250,000 (for single filers) or $500,000 (for married couples) of the gain from the sale of their primary home, provided they’ve lived in it for at least two of the last five years.
- For an Investment Property: An investor will pay capital gains tax on the profit from the sale. They may also have to pay a “depreciation recapture” tax.
The type of mortgage you used to buy the property has no direct effect on your capital gains calculation. The gain is simply the sale price minus your cost basis (what you paid for it, plus improvements). The huge savings you realized from the 2.75% loan are not considered income and are not taxed. They are simply savings that increase your personal net worth.
A Note on Points and Closing Costs
Some closing costs, such as loan origination fees or “points” paid to lower an interest rate, may be deductible. These rules, found in IRS Publication 936, can be complex. Generally, points can often be deducted over the life of the loan. This is another area where consulting a tax professional is essential to ensure you are complying with the law.
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Frequently Asked Questions (FAQs)
1. Is it better to have a higher mortgage interest rate for tax purposes? Absolutely not. This is a common and costly myth. You should never willingly pay a dollar in interest just to get a potential tax deduction of 20-40 cents. The direct cash savings from a lower interest rate will always be more valuable.
2. What is the difference between a tax credit and a tax deduction? A tax deduction reduces your taxable income. Its value depends on your marginal tax bracket. A tax credit is a dollar-for-dollar reduction of your actual tax bill. Tax credits are much more valuable than tax deductions. The mortgage interest benefit is a deduction, not a credit.
3. If I’m an investor, can I deduct both mortgage interest and depreciation? Yes. For an investment property, both the mortgage interest paid and the calculated depreciation are considered business expenses and can be deducted from the rental income to determine the net taxable income.
4. Does the seller have any tax implications from letting someone assume their loan? For the seller, the transaction is treated like any other home sale. Their capital gain is calculated as the final sale price minus their original cost basis. The fact that the loan was assumed does not change their capital gains calculation.
5. How does the premium paid for an assumable mortgage affect my taxes? For the buyer, the premium paid is simply part of the total purchase price of the home. This becomes part of their cost basis, which will be used to calculate their capital gain when they eventually sell the property in the future.
Numbers & Assumptions Disclaimer
All example payments, savings, interest totals, and timelines are illustrations based on the “Assumptions & Inputs” in this article as of the stated “Last updated” date. Actual results vary by buyer qualifications, lender/servicer approvals, program rules, rates in effect at application, and final contract terms. No guarantees are expressed or implied.
General Information Disclaimer
This article is for educational purposes only and is not financial, legal, tax, or lending advice. All transactions are subject to lender/servicer approval and applicable laws. Consult licensed professionals for advice on your situation.
References
- Internal Revenue Service (IRS). (n.d.). “Publication 936, Home Mortgage Interest Deduction”. Retrieved from irs.gov/publications/p936
- Internal Revenue Service (IRS). (n.d.). “Topic No. 701, Sale of Your Home”. (Regarding Capital Gains Exclusion). Retrieved from irs.gov/taxtopics/tc701
- Internal Revenue Service (IRS). (n.d.). “Publication 527, Residential Rental Property (Including Rental of Vacation Homes)”. Retrieved from irs.gov/publications/p527
- Tax Foundation. (2024). “Standard Deduction Amounts”. Retrieved from taxfoundation.org/data/all/federal/2024-tax-brackets/
- Consumer Financial Protection Bureau (CFPB). (n.d.). “What is the mortgage interest deduction?”. Retrieved from consumerfinance.gov
