With tax season coming up in just two months, learn exactly what the mortgage interest tax deduction is and why it benefits you.

If you've ever asked your accountant what more you could be doing during the year to lower your taxes, he or she has probably suggested that you should buy a house.

But what exactly does that mean? On what planet does buying a house make anything cheaper?

Obviously, plunking down the money for a down payment on a home isn't going to save you any money. But that's not where the taxes that you pay on your income come into play anyway.

What your accountant is talking about is reducing the amount that you pay for your taxes. How do you do that? A simplified explanation of taxes is that they are determined based on the amount that you make in a given year. To reduce your taxes, you need to reduce the amount of your income that can be taxed, otherwise known as taxable income.

Limitations

What the home mortgage interest deduction does is allow you to reduce your taxable income by the total amount of interest that you have paid on your mortgage.

There are, however, some limitations. First, to get the deduction, the taxpayer must elect to itemize deductions and the deductions must exceed the standard deduction. Secondly, the deduction only applies to a primary residence or a second home (no third or fourth homes, should you be so lucky!) up to $1 million dollars of debt.

The general idea behind the deduction is that it encourages people to own homes and frees up more money for them to spend on a home than they would have if they were renting. And it goes without saying that putting your money towards a mortgage every month and building equity is almost always better than throwing it away on rent. So, when you accountant suggests that it is in your best interest to buy a home, he or she has a point!

Published on June 1, 2007