With the cost of home ownership on the rise, it is important for first-time homebuyers to be aware of certain possible benefits available to help with affordability. One of these is the Section 25 mortgage interest credit, which can be claimed on a taxpayer’s Federal tax return for a portion of the mortgage interest paid.
Who Qualifies?
To receive this credit, a taxpayer must be issued a mortgage credit certificate (MCC). This is issued by a state or local government agency in the state of residence. In order to qualify for one, the taxpayer must be a first-time homebuyer, and the home securing the mortgage must be the taxpayer’s principal residence. Furthermore, the taxpayer must meet certain income and sales price limitations, and may be required to undergo some type of homebuyer education (these qualifications vary by state).
How Much Is It?
The mortgage interest credit is calculated on Form 8396, Mortgage Interest Credit. There are two amounts provided on the MCC that are used to calculate the credit – the certificate credit rate (CCR) and the certified indebtedness amount. The CCR is a percentage that is applied to mortgage interest amount paid to determine the amount of the credit – however, if it is more than 20 percent, the maximum allowable credit for a given year is $2,000 (it ranges from a minimum of 10 percent to a maximum of 50 percent). The certified indebtedness amount is the amount of the loan covered by the MCC – only the interest on that amount is eligible for the credit.
Another possible limit to the credit amount is based on tax liability. The credit is limited to something called the “applicable tax limit,” which is:
- The taxpayer’s tax liability less any foreign tax credit and alternative minimum tax, minus
- The total allowable nonrefundable tax credits (not including the mortgage interest credit, adoption credit, or the residential energy-efficient property credit).
Example 1:
Mortgage amount $200,000
Mortgage Interest paid during year $7,300
CCR: 30%
Interest paid x CCR = $2,190, but limited to $2,000 because CCR is more than 20%
Example 2:
Mortgage amount $200,000
Mortgage Interest paid during year $7,300
CCR: 20%
Applicable tax limit $1,300
Interest paid x CCR = $1,460, but credit limited to applicable tax limit of $1,300
What Happens to the Credit Amount I Can’t Use?
If a portion of the calculated credit amount is disallowed because of the CCR exceeding 20%, the excess over $2,000 cannot be carried forward. However, any credit amount in excess of the applicable tax limit can be carried forward for up to three years. So, in Example 2 above, the $160 of unused credit above the applicable tax limit amount is carried forward to the next year.
What Happens If I Refinance?
If you refinance your mortgage, you can still qualify for the credit if your existing MCC is reissued. The reissued certificate must meet the following requirements:
- It must be issued to the holder of the existing certificate for the same property.
- It must completely replace the existing certificate – no portion of the outstanding balance of the existing certificate can be retained.
- The indebtedness and credit rate cannot exceed those of the existing certificate.
- The reissued certificate cannot result in a higher calculated credit amount than what would otherwise have been allowed under the existing certificate (for any tax year).
Possible Disadvantages
For those taxpayers who deduct their mortgage interest on Schedule A, the deductible amount must be reduced by the amount of the credit received. It is still more advantageous to receive the credit than the additional deduction – furthermore, many taxpayers wouldn’t be impacted by this anyway, because more taxpayers are taking the standard deduction than previously (due to the increase in the standard deduction when the Tax Cuts and Jobs Act was passed). For those taking the standard deduction, there is no mortgage interest deduction to offset the credit against.
There are some situations where the credit may be subject to recapture, meaning that it must be repaid. If a taxpayer disposes of the residence within a nine-year period, some or all of the credit will be subject to recapture. However, if the taxpayer does not make significantly more income in the year of sale than in the year of purchase, or the taxpayer does not realize a gain on the sale of the home, the recapture amount would be reduced or possibly even eliminated. Some MCC programs will even reimburse taxpayers if they become subject to a recapture tax!
More Information
To find out more about the mortgage interest credit and how it is administered/how it might apply to their situation, taxpayers should contact their state or local government housing agency that is authorized to issue MCCs. More information can also be found in the IRS instructions for Form 8396: 2021 Form 8396 (irs.gov)