The Mortgage Interest Deduction in a $2 Million Housing Market
The federal deduction was designed around a $750,000 mortgage. In Santa Clara and San Mateo counties, that covers less than half of a typical house.
Bay Area buyers often assume that a large mortgage brings a large tax deduction. The reality is more limited. Federal law caps the amount of debt whose interest is deductible, California uses a different cap, and the standard deduction has grown large enough that many households get less benefit from itemizing than they expect. With the median single-family home in Santa Clara County near $1.92 million and San Mateo County near $2.15 million in mid-2026, understanding the ceiling matters before choosing a loan size.
The federal $750,000 cap
Under IRS Publication 936, interest is deductible only on the first $750,000 of acquisition debt for mortgages taken out after December 15, 2017, or $375,000 for married taxpayers filing separately. Mortgages originated before that date retain a $1 million limit. Acquisition debt means debt used to buy, build, or substantially improve a main or second home and secured by that home. This cap was scheduled to expire after 2025, but the One Big Beautiful Bill Act made the $750,000 limit permanent and, beginning in 2026, treats mortgage insurance premiums on acquisition debt as deductible mortgage interest.
The arithmetic for a Bay Area buyer is straightforward. Consider a hypothetical couple who buy a $2 million home with 20% down and a $1.6 million mortgage at 6.5%. First-year interest is roughly $104,000, but only the portion attributable to $750,000 of principal, about $48,750, is deductible federally. The remaining $55,000 or so of interest is simply a cost of housing.
Home equity debt and refinancing
Publication 936 is explicit that interest on a loan secured by your home is not deductible to the extent the proceeds were not used to buy, build, or substantially improve the home, regardless of when the loan was taken. A home equity line used for a kitchen remodel may qualify within the overall cap; the same line used to pay down student loans or fund a startup does not. Refinancing preserves the original acquisition debt character only up to the balance being refinanced; cash taken out above that balance is treated according to its use.
California is more generous, up to a point
State law did not conform to the 2017 federal change. The Franchise Tax Board allows a deduction on home purchases up to $1,000,000, compared with the federal $750,000. In the hypothetical above, the couple could deduct interest on $1 million of principal, about $65,000, on the California return. Because California's rates reach 9.3% to 12.3% for high earners, the state deduction is worth real money, but it still leaves a large share of the interest on a $1.6 million loan undeductible. Tracking two different limits on the same loan is a routine, if tedious, part of preparing a California return.
The standard deduction and SALT interaction
A deduction only helps to the extent itemized deductions exceed the standard deduction, which for 2026 is $16,100 for single filers and $32,200 for joint filers. Mortgage interest on $750,000 of debt, combined with state and local taxes, usually clears that bar for Bay Area homeowners. The state and local tax deduction, capped at $40,000 for 2025 and rising about 1% a year through 2029, phases down by 30% of modified AGI above $500,000 with a $10,000 floor, so the highest earners get a smaller SALT deduction and rely more on mortgage interest to justify itemizing. The value of the deduction also rises with the marginal rate, which means it is worth more to a household in the 37% bracket than to one in the 24% bracket, an effect that critics note makes the subsidy regressive.
What the deduction should not decide
The deduction reduces the after-tax cost of a mortgage; it does not make borrowing cheap. Interest above the cap is paid at full cost, and even deductible interest saves only the marginal rate, not the whole payment. A larger loan chosen for its tax benefit still increases monthly obligations, interest rate exposure, and the consequences of a job loss in a region where layoffs at major employers have continued through 2026. Deciding how much house to buy and how much to borrow is primarily a question of cash flow, stability, and life plans.
This article is educational only and is not tax, legal, or investment advice. Mortgage interest rules involve tracing, refinancing, and state conformity details that depend on individual facts, so consider consulting a qualified tax professional.
Important Disclosures
Important Disclosures: Propulsion Capital Management is an investment adviser registered with the State of California Department of Financial Protection and Innovation. Registration does not imply a certain level of skill or training. This article is provided for general informational and educational purposes only and does not constitute investment, tax, legal, or accounting advice, nor an offer or solicitation to buy or sell any security or to adopt any particular investment strategy. The information is believed to be accurate as of the date of publication but is subject to change without notice; tax laws and regulations change frequently and their application depends on individual facts and circumstances. Nothing herein should be relied upon as a substitute for personalized advice from a qualified professional. Investing involves risk, including the possible loss of principal, and past performance is no guarantee of future results. Diversification does not ensure a profit or protect against loss. Any examples are hypothetical, are for illustrative purposes only, and do not reflect the experience of any client. Links to third-party websites are provided for convenience; Propulsion Capital Management does not endorse, and is not responsible for, the content of third-party sites. Propulsion Capital Management does not provide tax or legal advice; please consult your tax adviser or attorney regarding your specific situation.
