Will I benefit from home mortgage interest deduction?

[webguy]

I could use some advice from you awesome clever mustachians on our current situation. We are in a very fortunate situation right now financially but would like some advice to try to optimize our tax savings. Here's the low down:

• Just purchased a new home which will have a starting mortgage balance of $500,000. Not very mustachian I know!
• Interest rate is 3.75%. We have a 10/1 ARM, but will have it paid off before the adjustable rate comes into effect.
• Our income is very high right now. In 2016 our AGI was $688,000. This income isn't guaranteed long term though. I run a software business, and currently revenue is good, but there's a real possibility it could decline in future, perhaps significantly.
• Tax brackets are 39.6% fed/9.85% state - married filing jointly.
• Currently have $950,000 in investments, about $150,000 in cash, $120,000 home equity in the new place, and after the sale of our current home goes through will have about $130,000 extra cash. Current networth is about $1.35M.
• Itemized deductions for 2016 were $54,700. This was limited as our AGI was over the $155,650 limit.

Our original plan was going to be to just kill the mortgage in 1 year.  We can put the $130,000 + $70,000 cash towards it right away and then pay off the remaining $300,000 in about a year.  However, I was listening to a podcast today and it mentioned that the mortgage interest deduction can be beneficial for higher mortgage balances and higher income households.  I'm not sure whether this will apply to us as our deductions are limited due to our high AGI, but if it does I'm wondering whether it's a mistake to pay it off so early and maybe pay it off over 10 years instead.

I understand the financial benefits of straight investing vs paying of the mortgage early - I don't really want to get into a discussion about that as it's been discussed endless times before.  I'm just trying to figure out whether we'll be missing out on a sizeable tax deduction if we pay off our mortgage early. I tried using a couple of mortgage interest deduction calculators but couldn't really make sense of the results for our situation - especially as our deductions are limited due to the high AGI.  I was thinking I could consult with a financial planner or something to see if they could help, but first I'd post here as you guys always seem to be much more knowledgeable than the advisers/CPAs I speak to.

So my question is: Would our situation allow us to be able to benefit substantially from deducting the mortgage interest - or would it be pretty negligible due to the deduction limit?

Any help or advice would be greatly appreciated!

[MDM]

Here's a quick look at a 2017 projection, using numbers from the OP.  Probably incorrect at several points, but if it bears any resemblance to reality you could download the case study spreadsheet and enter correct values.

This will do the Pease and Personal Exemption phaseouts, NIIT, AMT, and maybe some others I've forgotten that affect high incomes.

Category	Monthly	Comments	Annual
Salary/Wages for earner #1	$28,667		$344,000
Salary/Wages for earner #2	$28,667		$344,000
Federal Total Income	$57,333		$688,000
Federal tax	$15,854	2017 rates, MFJ, item. ded., 2 exempt.	$190,253
State/City tax	$5,160	Guess, using 9.00% * (AGI - Exempt'n)	$61,920
Soc. Sec.	$1,314	Assumes 2 earners paying	$15,773
Medicare	$1,160		$13,918
Total income taxes	$23,489		$281,864

Filing Status	2	1=S, 2=MFJ, 3=HOH
# Exemptions	2
	Adult #1	Adult #2
Age	31	31
# of earners	2
Total Income	$688,000
Std. Deduct.	$12,700
Act. Deduct.	$69,257
Exemption	$0
AGI	$688,000
MAGI	$688,000
Taxable	$618,744
1040 Tax	$190,253
Tax after n-r credit	$190,253
Net Tax	$190,253
Monthly	$15,854
Mtg. Int. (approx.)	$18,563
State tax	$61,920	9.00%
Item. Deduct.	$80,483
Version	V8.16

Loans:	Orig. Prin.	Orig. Length	Curr. Prin.	Yrs left	Rate
Mortgage	$500,000	30	$500,000	30	3.750%

[Tiger Stache]

I wish I had this problem

[caracarn]

Oh and holy crap - thanks for your contribution of 50% of your income to the tax pool.  We need more people like you!

:)

I think the most impressive thing about his original post is not this, but that he is aware that the advice he gets here is better than is provider by financial advisors and CPAs that someone with a very wonderful AGI could consult!  Glad we can help.

To answer OP question, it would seem you have a lot of the research already at your fingertips so not sure that we would find anything else.  On the surface, and I'm shooting from the hip here, the mortgage calculator will give you the total interest you could claim, but you already have a cap on deductions due to your high AGI.  It would then seem you need to figure out what deductions total before you add any mortgage interest.  If you then have enough space between that number and your limit you get to claim it all and that certainly helps lower your tax burden.  If it is not quite enough you lower it by that amount.  If you are already exceeding the limit then having the interest on your mortgage is of little value to you and I'd pay it off and invest.

[MDM]

...you already have a cap on deductions due to your high AGI.

It's not exactly a cap.

See PEP And Pease Limitation Are Really 1% Income Surtaxes for details.

[webguy]

Wow, thanks for all of the great responses guys. This has been genuinely very helpful and I really appreciate all of your time - especially MDM and bender.  I think I'm going to hold off for a year and see how beneficial the interest deduction is on our return for 2017, to see how much we actually save. I have a feeling it's going to be substantial enough to justify not paying it off in less than 10 years.

This leads to the next issue though...

What would you do with the cash that you would otherwise pay the mortgage with?  If that investment is expected to yield greater than 2% after tax, that's a good argument to keep the mortgage.

I'm honestly not sure, but I guess that's a good problem to have. If we don't put it towards the mortgage then I have about $220k in spare cash to do something with. Having already pumped about $800k into the market over the past 3 years I'm a little hesitant to keep pouring more in at the moment, and don't really want the headache of dealing with real estate. I guess this is the definition of a first world problem!...

[CmFtns]

Wow, thanks for all of the great responses guys. This has been genuinely very helpful and I really appreciate all of your time - especially MDM and bender.  I think I'm going to hold off for a year and see how beneficial the interest deduction is on our return for 2017, to see how much we actually save. I have a feeling it's going to be substantial enough to justify not paying it off in less than 10 years.

This leads to the next issue though...

What would you do with the cash that you would otherwise pay the mortgage with?  If that investment is expected to yield greater than 2% after tax, that's a good argument to keep the mortgage.

I'm honestly not sure, but I guess that's a good problem to have. If we don't put it towards the mortgage then I have about $220k in spare cash to do something with. Having already pumped about $800k into the market over the past 3 years I'm a little hesitant to keep pouring more in at the moment, and don't really want the headache of dealing with real estate. I guess this is the definition of a first world problem!...

The math is the same it's just the numbers that are bigger... I know that can be scary but I believe following a plan is even more important at larger numbers because emotions start to become more real and we all know how well emotional investing does...

No matter the scale that we talk about, the theory is the same. I would stick with the investment strategy that you have decided to follow and it seems like you know that should NOT be a 220k cash position.