Yes, you can deduct the mortgage interest (not the principal) on a rental property under U.S. federal tax law.
This tax break is a cornerstone for landlords, often saving them thousands every year. In fact, roughly 7% of U.S. tax filers (about 10.6 million Americans) report rental income – and nearly all of them benefit from writing off their mortgage interest. Here’s everything you need to know about this deduction, with expert tips and examples to maximize your savings.
- 🤑 Maximize Rental Tax Write-Offs: Learn how claiming mortgage interest (the biggest part of your payment) can slash your taxable rental income.
- ⚠️ Avoid Costly Mistakes: Find out common errors (like deducting principal or misusing loan funds) and how to stay on the right side of IRS rules.
- 💡 Insider Strategies: Discover tips on combining interest deductions with depreciation, navigating passive loss limits, and planning for optimal tax benefits.
- 📋 Step-by-Step Guidance: Get a clear explanation of IRS forms (like Schedule E) and see exactly how to report your mortgage interest and other expenses.
- 🏛️ Law & Loopholes Demystified: Understand the latest tax laws, IRS regulations, and even key court rulings that affect your rental property write-offs.
Mortgage Interest vs Principal: What Can You Deduct?
It’s critical to distinguish between the interest and principal portions of your mortgage payment. Mortgage interest is the charge for borrowing money, and for a rental property it’s considered a business expense. That means the interest you pay each year is tax-deductible, directly reducing your rental income for tax purposes. Mortgage principal, on the other hand, is the money you repay to the lender to reduce your loan balance. Paying back principal builds your equity in the property, but it’s not deductible because it’s not an expense – it’s more like repaying your own debt to acquire the asset.
Think of it this way: The interest is the “rent” you pay on the money you borrowed, so the IRS lets you write it off as a cost of doing business. The principal payment is just returning borrowed money, so you don’t get a tax break for that.
For example, if your monthly mortgage payment is $1,000 and $700 of that is interest (with $300 going toward principal), only the $700 is deductible. The $300 principal simply increases your ownership stake in the property and won’t show up as an expense on your tax return. One implication of mortgage amortization is that the interest portion of your payment is highest in the early years and decreases as the loan balance goes down. That means your interest write-off (and your tax savings) will be larger in the beginning of the loan’s term and gradually shrink each year.
It’s a common mistake for new landlords to try to deduct the entire mortgage payment. Don’t do that. The IRS expects you to separate interest from principal. Typically, your lender will send an annual statement (Form 1098) showing exactly how much interest you paid for the year. Always use that interest figure for your deduction, not the total amount you paid the bank.
How to Deduct Mortgage Interest on a Rental Property
Report it on Schedule E (Form 1040). For individual landlords, rental income and expenses get reported on Schedule E of your tax return. Mortgage interest is one of the expense lines on Schedule E, separate from other costs like repairs or property taxes. You’ll simply enter the total interest paid for the year on the line for mortgage interest. (If you have multiple rental properties, report each property’s interest expense separately—usually by using a separate column or a separate Schedule E for each property as needed.)
No need to itemize deductions. Unlike the mortgage interest on your personal residence (which only helps if you itemize on Schedule A), interest on a rental property is deducted above-the-line as a business expense. This means you can take the standard deduction for your personal taxes and still fully deduct rental property interest separately. The interest write-off directly reduces your rental income before it ever reaches your adjusted gross income.
When you prepare your taxes, use the Form 1098 from your lender to find the exact interest amount paid. Make sure to include all mortgage interest for the rental: this could include interest on a primary mortgage, a second mortgage, or even a home equity loan if that loan was used for the rental property. The IRS receives a copy of Form 1098 as well, so the interest you claim should match what was reported by the lender.
If your rental is owned by a business entity (like an LLC or partnership), the concept is the same: the business’s tax return will deduct the mortgage interest as an expense against rental income. For commercial properties or multi-unit rentals, interest also remains fully deductible. The key is that the property is used to produce income – as long as it’s a bona fide rental or business property, all interest tied to that property’s mortgage is a valid deduction.
Special Situations: Refinancing, Points, and Home Equity Loans
Refinancing and cash-out loans: If you refinance your rental property’s mortgage, the interest on the new loan is equally deductible as the interest on the original loan. However, be careful with cash-out refinances – if you take out extra cash and use it for something unrelated to the property, the interest on that portion of the loan is not deductible as a rental expense. The IRS uses “interest tracing” rules, meaning the deductibility of interest depends on how the borrowed money is used. So, if you pull equity out of your rental to, say, buy a personal car or pay college tuition, you cannot write off the interest on that personal-use portion of the debt.
Loan points and origination fees: Points (prepaid interest) or loan origination fees on a rental mortgage are deductible too, but not all at once. Instead of taking the full deduction in the year you paid them, you generally must amortize those costs over the life of the loan.
For example, if you paid $3,000 in points on a 15-year mortgage, you’d deduct about $200 per year for 15 years. (If you pay off the loan or refinance again early, any remaining unamortized points from the old loan can be deducted in that year.) Unlike an owner-occupied home mortgage (where points for a purchase can sometimes be deducted fully in the first year), a rental property’s loan points have to be spread out over the loan term.
Home equity loans and HELOCs: Interest on a second mortgage, home equity loan, or HELOC tied to your rental property is also deductible if the funds are used for the rental (for instance, renovating the property or buying another rental asset). Just like with a refinance, you should use the loan proceeds for the property itself. If you use a HELOC on your rental to upgrade the rental unit, that interest is a write-off. But if you use a HELOC on your personal home to fund your rental business, that interest isn’t deductible on Schedule E (it might be considered investment interest or nondeductible personal interest, depending on the situation).
Mixed-use properties: If a property serves as both your personal home and a rental (such as a duplex where you live in one unit and rent out the other, or a vacation home you partly rent out), you must split the mortgage interest between personal and rental use. You can only deduct the portion of interest attributable to the rental portion.
Typically, this is done based on the percentage of the property rented or the number of days rented during the year. The personal portion of interest may still be deductible as home mortgage interest on Schedule A (subject to the usual home mortgage limits), but you cannot double-dip. Only the rental-use percentage of interest goes on Schedule E.
Depreciation: Deducting the Property’s Cost Over Time
So if you can’t deduct the principal portion of mortgage payments, how do you ever deduct the cost of the property itself? The answer is depreciation. Depreciation lets you write off the purchase price (or construction cost) of the rental property over a number of years. For residential rental real estate (like houses or apartments), the IRS allows a 27.5-year recovery period. For commercial properties (non-residential real estate), it’s 39 years. Essentially, you get to deduct a fraction of the building’s value each year as a wear-and-tear or usage expense, even if the property is actually rising in market value.
How depreciation works: First, you determine your “basis” in the building (generally what you paid for the property, minus the value of the land, since land isn’t depreciable). Say you bought a rental home for $300,000, with the land valued at $60,000 and the building at $240,000. You can depreciate that $240,000 building value over 27.5 years. That yields about $8,727 per year of depreciation expense ($240,000 ÷ 27.5). You would claim this depreciation each year on Schedule E, reducing your taxable rental income, even though it’s a non-cash expense.
The result is that over time you are deducting the principal indirectly by depreciating the asset you acquired with that principal. For example, if you pay down $10,000 of loan principal this year, you can’t deduct that outright – but you might be taking around $8,700 of depreciation expense on the building’s value (plus still deducting your interest and other expenses). This combination often means your rental can show a tax loss even if you had positive cash flow. It’s a tax advantage: you collect rent and maybe pay down your mortgage, but still report a loss or very low taxable income thanks to interest and depreciation deductions. That loss can potentially offset other rental profits or get carried forward for future use (subject to the passive activity loss limitations).
Keep in mind that depreciation is essentially mandatory for rental property. Even if you don’t claim it, the IRS will assume you did when you eventually sell (due to depreciation recapture rules). So you’re almost always better off claiming it each year. Depreciation can be complex (there are concepts like bonus depreciation and different methods), but the key point is: depreciation is how you deduct the cost of the property itself over time, complementing the mortgage interest deduction (which covers the cost of borrowing the money).
Mistakes to Avoid When Deducting Mortgage Expenses
Even savvy investors can slip up on rental property tax rules. Here are some common mistakes to watch out for:
- Trying to deduct the entire mortgage payment: Remember, only the interest is deductible – not the principal. Some landlords mistakenly write off their full mortgage payment as an expense, which will draw IRS scrutiny. Always separate interest from principal.
- Deducting interest on funds used for personal expenses: If you take out a loan against your rental (or refinance and pull cash out) and spend that money on personal use (a car, vacation, etc.), you cannot deduct that portion of the interest. Only interest on debt used for the rental property or its business purposes is deductible. Don’t try to sneak personal interest in as a rental expense; tax courts have disallowed such deductions when the loan proceeds weren’t used for the rental.
- Not splitting interest for mixed-use properties: When a property is part personal residence and part rental (or a vacation home you rent out part of the time), you have to allocate the interest. One common error is deducting 100% of the interest on Schedule E when you actually used the place personally for part of the year. Make sure you only deduct the portion corresponding to the rental use. The rest, if eligible, might go on Schedule A as personal mortgage interest (subject to the home mortgage limits), but it shouldn’t all be claimed as a rental expense.
- Forgetting to depreciate (or misclassifying improvements): While not a direct “mortgage” deduction issue, it’s related – some landlords fail to claim depreciation on the rental or they improperly deduct large improvements as if they were repairs. Failing to take depreciation means losing a huge tax benefit and can cause trouble when you sell. Always distinguish immediate repair expenses (deductible right away) from capital improvements (which must be depreciated over time), and be sure you’re depreciating the property each year.
- Ignoring passive activity loss limits: New rental owners are sometimes surprised that a rental “tax loss” (often created by large interest and depreciation deductions) may not reduce their other income. By default, rental losses are considered passive and generally can only offset passive income. There is a special allowance (up to $25,000 of loss per year) for active landlords with moderate incomes, but above certain income levels this benefit phases out and excess losses get suspended (carried forward to future years). Don’t assume you can write off a big rental loss against your W-2 salary or other active income unless you meet the criteria (or qualify as a real estate professional under IRS rules). Be aware of the passive loss limitations and plan accordingly so you’re not caught off guard at tax time.
Rental Property vs. Personal Residence: Mortgage Interest Deduction Compared
It’s important to note the difference between the mortgage interest deduction for a rental property versus for your own home. For your primary residence (or second home), mortgage interest is an itemized deduction on Schedule A and it’s subject to limits – for example, interest on up to $750,000 of home acquisition debt (for loans originated after 2017) can be deducted. You only get a benefit if you itemize your deductions, and the deduction reduces your taxable income on your personal return.
For rental properties, mortgage interest is a business expense reported on Schedule E. There’s no specific dollar cap on the loan amount for deductibility – even if you have a large mortgage, all the interest is deductible (the only restrictions would be the passive loss rules or, in rare cases, the business interest limitation for large real estate companies). Rental interest deductions also don’t depend on itemizing; they reduce your rental income directly.
In short, the tax treatment is more favorable: every dollar of interest on a rental loan can offset your rental income (or other passive income), whereas home mortgage interest might give no tax benefit if you take the standard deduction or exceed the loan limit.
Another difference: Private mortgage insurance (PMI) on a personal home has its own limited deduction (only in certain years and with income phase-outs), but insurance on a rental property is just another business expense fully deductible on Schedule E. Also, personal residence interest is never “suspended” or carried forward – you either deduct it that year (if you itemize) or not at all – while unused rental losses can carry forward if you can’t use them immediately. These distinctions help explain why many tax-savvy investors favor rental property for tax purposes: the interest and other expenses are more easily deducted and less restricted than on a personal home.
Big Landlords and Interest Limitations (Section 163(j))
Most landlords will never have to worry about this, but it’s good to know: under the tax code’s Section 163(j), very large businesses may face a cap on business interest deductions. This rule can limit the deductible interest to 30% of adjusted taxable income for businesses above a certain size. However, real estate companies can usually elect out of this limitation. In practice, if you’re a massive real estate investor or company with average gross receipts above the IRS “small business” threshold (around $30 million in annual revenue as of 2024), you might need to file Form 8990 to calculate your allowed interest. Real estate businesses can avoid the 30% interest cap by opting to use the Alternative Depreciation System (ADS) for their properties (which slightly slows down depreciation). The bottom line: small and mid-size landlords can deduct all their rental mortgage interest without concern, while mega-landlords should be mindful of Section 163(j) rules.
Pros and Cons of Deducting Rental Property Mortgage Interest
| Pros | Cons |
|---|---|
| Lowers taxable income: Reduces your rental profits on paper, saving you money at tax time each year. | Partial benefit only: It only reduces part of your interest cost (you still pay the interest; the tax break just covers a fraction of it). |
| Makes leverage cheaper: The tax deduction effectively subsidizes your interest, making it more affordable to finance properties. | Passive loss limits: If your rental operates at a loss, you might not realize the tax benefit immediately due to passive loss rules (unused losses carry forward). |
| No loan size cap: Unlike the home mortgage deduction, there’s no $750k limit – all interest on your rental loan is deductible, no matter how large. | Record-keeping required: You need to track expenses and file the correct forms (Schedule E, etc.). Mistakes or poor documentation could lead to IRS issues or missed deductions. |
| Not tied to itemizing: You can claim this write-off even if you take the standard deduction on your personal return. | Declines over time: As you pay down the mortgage, your interest (and deductible amount) decreases each year, so the tax break diminishes in later years of the loan. |
In summary, deducting mortgage interest is a valuable tax benefit that can significantly improve your rental investment’s after-tax returns. However, it shouldn’t be the sole reason to take on debt – you’re still spending money on interest. The deduction simply helps recoup some of that cost. Smart investors leverage this benefit while also ensuring the underlying investment makes sense on its own.
The Bottom Line on Rental Mortgage Deductions
Mortgage interest on rental properties is one of the most significant tax breaks available to real estate investors. It can substantially reduce your taxable rental income, especially in the early years of a loan when interest is highest. By combining interest deductions with other tools like depreciation, landlords can often minimize or even eliminate the taxes on their rental income (at least in the short term). The key is understanding the rules – interest yes, principal no – and following them carefully.
As long as you borrow for legitimate rental purposes and keep good records, the tax code is on your side. Deducting mortgage interest won’t make your loan payments go away, but it will soften the blow by letting Uncle Sam share some of the cost. In the end, this deduction helps make owning rental property more affordable and profitable.
FAQ
Q: Can I deduct my entire mortgage payment for a rental property?
A: No. Only the interest portion of your mortgage payment is deductible (along with related expenses like property taxes and insurance as separate write-offs). The principal portion is not tax-deductible.
Q: Do I have to itemize my taxes to deduct mortgage interest on a rental?
A: No. Rental property mortgage interest is deducted on Schedule E as a business expense, separate from itemized deductions. You can take the standard deduction and still fully deduct your rental interest.
Q: If my rental was vacant part of the year, can I still deduct the mortgage interest?
A: Yes. As long as the property was available for rent (actively advertised or in use for rental) during that period, you can deduct the mortgage interest for those months even if no rent was received.
Q: Can I deduct a rental loss if my expenses (mortgage interest, etc.) exceed the rental income?
A: Yes. You can report a rental loss on your tax return, but passive activity loss rules may prevent using that loss against other income (unused losses carry forward to future years).
Q: Is interest on a cash-out refinance or HELOC for my rental property deductible?
A: Yes – if the funds are used for the rental. If you use the money for personal expenses, the interest on that portion isn’t deductible as a rental expense.