Tax Code 163: Mortgage and Business Interest Deductions

Section 163 of the Internal Revenue Code allows a deduction for three kinds of interest: interest on a mortgage secured by your home, interest on money borrowed to buy investments, and business interest. Everything else — credit cards, auto loans, personal lines of credit — is nondeductible personal interest. The tax code 163 interest deduction comes with dollar caps, income limits, and forms specific to each category, and two of the three categories only help if you itemize instead of taking the standard deduction.

Mortgage Interest Under Section 163(h)

The mortgage interest piece of Section 163 covers debt secured by a qualified residence. That means your main home plus one other home you designate as a second residence. A second home only counts if it has sleeping quarters, a kitchen, and a bathroom; boats and RVs qualify on the same terms.

For any mortgage taken out after December 15, 2017, interest is deductible on up to $750,000 of debt, or $375,000 if you file married filing separately. These caps were scheduled to sunset after 2025, but the One Big Beautiful Bill Act, signed July 4, 2025, made them permanent.¹ Mortgages taken out on or before December 15, 2017, keep the older $1 million cap ($500,000 if married filing separately).²

If your balance sits above the cap, you deduct a pro-rated share. A $1 million mortgage originated in 2024 by a joint filer produces a deduction for 75 percent of the interest paid that year ($750,000 divided by $1,000,000).

Home equity loans need care. The deduction for standalone home equity interest is gone permanently.³ The interest is only deductible if you use the loan to buy, build, or substantially improve the home securing it, in which case it counts as acquisition debt and sits inside the same $750,000 cap. Using a home equity loan for a vacation or to consolidate credit card balances produces no deduction.

The debt has to be secured under your local recording laws. An unrecorded lien lets the IRS reclassify the interest as nondeductible personal interest even if you paid every installment on time.

Homes Under Construction

A home you are building can be treated as a qualified residence for up to 24 months while construction is going on, as long as it actually becomes your qualified residence when finished. The 24-month clock can start any time on or after the day construction begins.² The construction loan interest during that window falls under the same $750,000 acquisition-debt cap.

Points, Refinancing, and PMI

Points are prepaid interest charged as a percentage of the loan. On a purchase of your main home, you can usually deduct them in full the year you pay them, provided the loan is secured by that home, points are customary in your area, you use the cash method, and the funds you brought to closing were at least equal to the points charged.²

Refinance points are different. You spread the deduction over the life of the new loan. The exception: any portion tied to money used to substantially improve your main home is deductible in the year paid.

Refinancing a pre-December 16, 2017, mortgage does not automatically strip its grandfathered $1 million cap. The new loan keeps the higher limit if the refinanced balance is no larger than what you owed just before the refinance, and the new term does not run past the remaining term of the old loan. Balloon notes get a special allowance of up to a 30-year replacement term.² Any cash-out above the old balance falls under the $750,000 cap.

Private mortgage insurance premiums are treated as deductible mortgage interest again starting with the 2026 tax year. The deduction had expired after 2021 and was reinstated permanently by the One Big Beautiful Bill Act. If you pay PMI because your down payment was under 20 percent, those premiums now behave like mortgage interest, subject to the same itemizing requirement covered below.

Investment Interest Under Section 163(d)

Section 163(d) covers interest on money borrowed to buy investments such as stocks, bonds, and undeveloped land. The ceiling: you can deduct investment interest only up to your net investment income for the year.³ Net investment income means investment income (interest, nonqualified dividends, short-term capital gains, royalties) minus investment expenses other than interest.

Long-term capital gains and qualified dividends stay out of that calculation by default because they enjoy lower tax rates. You can elect to pull some or all of them into investment income, raising your ceiling, but anything you pull in loses its preferential rate and gets taxed as ordinary income. The election is made on Form 4952, and the IRS lets you file an amended return within six months of the original due date to make it if you missed it initially.⁴

Investment interest above your net investment income carries forward indefinitely. It waits until a future year gives you enough income to absorb it.

One boundary worth flagging. Interest on loans for rental property is not investment interest under 163(d). Rental activity falls under the passive activity rules of Section 469, and the interest goes on Schedule E with the rental income rather than on Form 4952.⁵ Reporting rental interest alongside margin interest is a common mistake.

Business Interest Under Section 163(j)

Section 163(j) caps how much business interest a company can deduct in a year. The cap only applies to businesses whose average annual gross receipts over the prior three years top $31 million for 2025, a figure the IRS adjusts each year for inflation.⁶ Smaller businesses can deduct their interest in full.

For a business above the threshold, the deduction in a given year is the sum of three items:

Business interest income earned during the year
30 percent of adjusted taxable income (ATI), which is the main component
Floor plan financing interest, which mostly matters for auto dealers and other inventory-heavy sellers

ATI got tighter starting in 2022. Depreciation and amortization can no longer be added back when computing it, so the 30 percent figure now sits on a smaller base.⁶ For partnerships and S corporations the limitation runs at the entity level and then flows to the owners through their distributive share. Any interest disallowed in one year carries forward.

Real Estate and Farming Can Opt Out

Real property trades or businesses and farming businesses can make an irrevocable election out of the 163(j) cap, regardless of gross receipts.⁷ The price of the election: you have to switch to the alternative depreciation system for certain property, which slows your depreciation deductions. Whether it pays off depends on how much interest you carry against how much accelerated depreciation you would give up.

Do You Actually Benefit? The Itemizing Question

Mortgage interest and investment interest are itemized deductions. They only help if your itemized deductions in total beat the standard deduction. For 2026, the standard deduction is $16,100 for single filers, $32,200 for joint filers, and $24,150 for heads of household.⁸

A married couple with a $300,000 mortgage at 6.5 percent pays about $19,500 in interest for the year. Add the $10,000 state and local tax cap and the total itemized figure is $29,500, still below the $32,200 standard deduction. That couple gets no tax benefit from their mortgage interest at all. You need a large enough loan balance, or enough other deductions, to clear the threshold before Section 163(h) puts anything back in your pocket. Business interest under 163(j) works differently: it reduces business income directly and does not depend on itemizing.

Forms, Records, and How to Claim It

Your lender sends Form 1098 by January 31 each year showing the mortgage interest you paid. That figure goes on Schedule A of Form 1040.⁹ If you closed on a home during the year, your closing disclosure will show any points or prorated interest paid at settlement, which may also be deductible.

Investment interest expense is calculated on Form 4952 before the deductible amount transfers to Schedule A. Keep records tying the borrowed funds to the investments you bought, since the tracing rules require you to connect loan proceeds to specific purchases.⁴

Businesses subject to 163(j) complete Form 8990 to calculate the deductible interest before entering the result on their main return. Partnerships and S corporations file it at the entity level.

Hold on to Form 1098, bank statements showing how loan proceeds were used, and closing disclosures for at least three years after filing. That is the standard window in which the IRS can assess additional tax on the return.¹⁰

1
Internal Revenue Service. One, Big, Beautiful Bill Provisions
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Internal Revenue Service. Publication 936, Home Mortgage Interest Deduction
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Office of the Law Revision Counsel. 26 USC 163 – Interest
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Internal Revenue Service. Form 4952, Investment Interest Expense Deduction
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Internal Revenue Service. Publication 550, Investment Income and Expenses
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Internal Revenue Service. Questions and Answers About the Limitation on the Deduction for Business Interest Expense
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eCFR. 26 CFR 1.163(j)-9 – Elections for Excepted Trades or Businesses
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Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026
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Internal Revenue Service. Instructions for Form 1098 – Mortgage Interest Statement
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Internal Revenue Service. Topic No. 305, Recordkeeping