From the Patrick Parker Realty Tax Season Blog Series:
Deducting Mortgage Interest FAQs
If you’re a homeowner, you probably qualify for a deduction on your home mortgage interest. The tax deduction also applies if you pay interest on a condominium, cooperative, mobile home, boat or recreational vehicle used as a residence.
It pays to take mortgage interest deductions
If you itemize, you can usually deduct the interest you pay on a mortgage for your main home or a second home, but there are some restrictions.
Here are the answers to some common questions about this deduction:
1. What counts as mortgage interest?
2. Is my house a home?
3. Who gets to take the deduction?
4. Is there a limit to the amount I can deduct?
5. What if my situation is special?
6. What types of loans get the deduction?
7. What if I refinanced?
8. What kind of records do I need?
What counts as mortgage interest?
Mortgage interest is any interest you pay on a loan secured by a main home or second home.
These loans include:
• A mortgage to buy your home
• A second mortgage
• A line of credit
• A home equity loan
If the loan is not a secured debt on your home, it is considered a personal loan, and the interest you pay usually isn’t deductible.
Your home mortgage must be secured by your main home or a second home. You can’t deduct interest on a mortgage for a third home, a fourth home, etc.
Is my house a home?
For the IRS, a home can be a house, condominium, cooperative, mobile home, boat, recreational vehicle or similar property that has sleeping, cooking and toilet facilities.
Who gets to take the deduction?
You do, if you are the primary borrower, you are legally obligated to pay the debt and you actually make the payments. If you are married and both you and your spouse sign for the loan, then both of you are primary borrowers. If you pay your son’s or daughter’s mortgage to help them out, however, you cannot deduct the interest unless you co-signed the loan.
Is there a limit to the amount I can deduct?
Yes, your deduction is generally limited if all mortgages used to buy, construct, or improve your first home (and second home if applicable) total more than $1 million ($500,000 if you use married filing separately status).
You can also generally deduct interest on home equity debt of up to $100,000 ($50,000 if you’re married and file separately) regardless of how you use the loan proceeds.
For details, see IRS Publication 936: Home Mortgage Interest Deduction.
What if my situation is special?
Here are a few special situations you may encounter.
• If you have a second home that you rent out for part of the year, you must use it for more than 14 days or more than 10 percent of the number of days you rented it out at fair market value (whichever number of days is larger) for the home to be considered a second home for tax purposes. If you use the home you rent out for fewer than the required number of days, your home is considered a rental property, not a second home.
• You may treat a different home as your second home each tax year, provided each home meets the qualifications noted above.
• If you live in a house before your purchase becomes final, any payments you make for that period of time are considered rent. You cannot deduct those payments as interest, even if the settlement papers label them as interest.
• If you used the proceeds of a home loan for business purposes, enter that interest on Schedule C if you are a sole proprietor, and on Schedule E if used to purchase rental property. The interest is attributed to the activity for which the loan proceeds were used.
• If you own rental property and borrow against it to buy a home, the interest does not qualify as mortgage interest because the loan is not secured by the home itself. Interest paid on that loan can’t be deducted as a rental expense either, because the funds were not used for the rental property. The interest expense is actually considered personal interest, which is no longer deductible.
• If you used the proceeds of a home mortgage to purchase or “carry” securities that produce tax-exempt income (municipal bonds) , or to purchase single-premium (lump-sum) life insurance or annuity contracts, you cannot deduct the mortgage interest. (The term “to carry” means you have borrowed the money to substantially replace other funds used to buy the tax-free investments or insurance.).
What kinds of loans get the deduction?
If all your mortgages fit one or more of the following categories, you can generally deduct all of the interest you paid during the year.
• Mortgages you took out on your main home and/or a second home on or before October 13, 1987 (called “grandfathered” debt, because these are mortgages that existed before the current tax rules for mortgage interest took effect).
• Mortgages you took out after October 13, 1987 to buy, build or improve your main home and/or second home (called acquisition debt) that totaled $1 million or less throughout the year ($500,000 if you are married and filing separately from your spouse).
• Home equity debt you took out after October 13, 1987 on your main home and/or second home that totaled $100,000 or less throughout the year ($50,000 if you are married and filing separately). Interest on such home equity debt is generally deductible regardless of how you use the loan proceeds, including to pay college tuition, credit card debt, or other personal purposes. This assumes the combined balances of acquisition debt and home equity do not exceed the home’s fair market value at the time you take out the home equity debt.
If a mortgage does not meet these criteria, your interest deduction may be limited. To figure out how much interest you can deduct and for more details on the rules summarized above, see IRS Publication 936: Home Mortgage Interest Deduction.
What if I refinanced?
When you refinance a mortgage that was treated as acquisition debt, the balance of the new mortgage is also treated as acquisition debt up to the balance of the old mortgage. The excess over the old mortgage balance is treated as home equity debt. Interest on up to $100,000 of that excess debt may be deductible under the rules for home equity debt. Also, you can deduct the points you pay to get the new loan over the life of the loan, assuming all of the new loan balance qualifies as either acquisition debt or home equity debt of up to $100,000.
That means you can deduct 1/30th of the points each year if it’s a 30-year mortgage—that’s $33 a year for each $1,000 of points you paid. In the year you pay off the loan—because you sell the house or refinance again—you get to deduct all the points not yet deducted, unless you refinance with the same lender. In that case, you add the points paid on the latest deal to the leftovers from the previous refinancing and deduct the expense on a pro-rated basis over the life of the new loan.
What kind of records do I need?
In the event of an IRS inquiry, you’ll need the records that document the interest you paid. These include:
• Copies of Form 1098: Mortgage Interest Statement. Form 1098 is the statement your lender sends you to let you know how much mortgage interest you paid during the year and, if you purchased your home in the current year, any deductible points you paid.
• Your closing statement from a refinancing that shows the points you paid, if any, to refinance the loan on your property.
• The name, Social Security number and address of the person you bought your home from, if you pay your mortgage interest to that person, as well as the amount of interest (including any points) you paid for the year.
• Your federal tax return from last year, if you refinanced your mortgage last year or earlier, and if you’re deducting the eligible portion of your interest over the life of your mortgage.
Keep in mind that this is general information designed to help you put these valuable deductions on your radar. Patrick Parker Realty Agents and Realtors are not certified accountants. Please be sure to check with your tax adviser to see if you qualify for a particular credit or deduction.
The Patrick Parker Realty Tax Season Blog Series will cover many topics as they relate to real estate and increasing your income tax refund. Such topics will include Home Ownership Tax Breaks, Hidden Tax Deductions, Deductions on Mortgage Interest, Reporting on the Sale of Your Home, Home Purchase Tax Credits and more. In addition, our Blog Series will explore Tax Incentives as they relate to major transitions and lifestyles; Marriage, Birth, Divorce, Death of Spouse, Health Insurance, Caretaking of Dependents, Business Owners, Commuters and more.
Check in to The Patrick Parker Realty Blog each Tuesday, Thursday and Saturday through Tax Day for new posts. You can also follow The Patrick Parker Realty Tax Season Blog Series on Facebook and Twitter using #taxseasonblog.
For more information about paying taxes on the sale or purchase of your home or any other questions you have about this article please speak with your tax professional or visit www.irs.gov.