Deductible Mortgage Interest

The mortgage interest deduction is one of the largest tax benefits available to all homeowners and investors who borrow money to fund their real estate purchases. Generally, home mortgage interest is any interest you pay on a loan secured by your home (main home or a second home). The loan may be a mortgage to buy your home, a second mortgage, a line of credit, or a home equity loan.

IRS Publication 936 describes this deduction in detail:

You can deduct home mortgage interest if all the following conditions are met.

• You file Form 1040 and itemize deductions on Schedule A (Form 1040).
  
• The mortgage is a secured debt on a qualified home in which you have an ownership interest. 
  

 Both you and the lender must intend that the loan be repaid.

Fully deductible interest.   In most cases, you can deduct all of your home mortgage interest. How much you can deduct depends on the date of the mortgage, the amount of the mortgage, and how you use the mortgage proceeds.   If all of your mortgages fit into one or more of the following three categories at all times during the year, you can deduct all of the interest on those mortgages.

The three categories are as follows.

1. Mortgages you took out on or before October 13, 1987 (called grandfathered debt).
   
2. Mortgages you took out after October 13, 1987, to buy, build, or improve your home (called home acquisition debt), but only if throughout 2014 these mortgages plus any grandfathered debt totaled $1 million or less ($500,000 or less if married filing separately).
   
3. Mortgages you took out after October 13, 1987, other than to buy, build, or improve your home (called home equity debt), but only if throughout 2014 these mortgages totaled $100,000 or less ($50,000 or less if married filing separately) and totaled no more than the fair market value of your home reduced by (1) and (2).
   

The dollar limits for the second and third categories apply to the combined mortgages on your main home and second home.
You can deduct your home mortgage interest only if your mortgage is a secured debt. A secured debt is one in which you sign an instrument (such as a mortgage, deed of trust, or land contract) that:

• Makes your ownership in a qualified home security for payment of the debt,
  
• Provides, in case of default, that your home could satisfy the debt, and
  
• Is recorded or is otherwise perfected under any state or local law that applies.
  

In other words, your mortgage is a secured debt if you put your home up as collateral to protect the interests of the lender. If you cannot pay the debt, your home can then serve as payment to the lender to satisfy (pay) the debt.

Wraparound mortgage.   This is not a secured debt unless it is recorded or otherwise perfected under state law.

For you to take a home mortgage interest deduction, your debt must be secured by a qualified home. This means your main home or your second home. A home includes a house, condominium, cooperative, mobile home, house trailer, boat, or similar property that has sleeping, cooking, and toilet facilities.

The interest you pay on a mortgage on a home other than your main or second home may be deductible if the proceeds of the loan were used for business, investment, or other deductible purposes. Otherwise, it is considered personal interest and is not deductible.

Main home.   You can have only one main home at any one time. This is the home where you ordinarily live most of the time. 

Second home.   A second home is a home that you choose to treat as your second home. 

Second home not rented out.   If you have a second home that you do not hold out for rent or resale to others at any time during the year, you can treat it as a qualified home. You do not have to use the home during the year. 

Second home rented out.   If you have a second home and rent it out part of the year, you also must use it as a home during the year for it to be a qualified home. You must use this home more than 14 days or more than 10% of the number of days during the year that the home is rented at a fair rental, whichever is longer. If you do not use the home long enough, it is considered rental property and not a second home.

Amounts charged for services.    Amounts charged by the lender for specific services connected to the loan are not interest. Examples of these charges are:

• Appraisal fees,
  
• Notary fees, and
  
• Preparation costs for the mortgage note or deed of trust.

You cannot deduct these amounts as points either in the year paid or over the life of the mortgage.

You can treat amounts you paid during 2014 for qualified mortgage insurance as home mortgage interest. The insurance must be in connection with home acquisition debt, and the insurance contract must have been issued after 2006.

Qualified mortgage insurance.   Qualified mortgage insurance is mortgage insurance provided by the Department of Veterans Affairs, the Federal Housing Administration, or the Rural Housing Service, and private mortgage insurance.

Limit on deduction.  The only allowable deduction affected by income limits is the deduction for mortgage insurance premiums. If your adjusted gross income is more than $100,000 ($50,000 if your filing status is married filing separately), the amount of your mortgage insurance premiums that are otherwise deductible is reduced and may be eliminated. 

Form 1098.   The mortgage interest statement you receive should show not only the total interest paid during the year, but also your mortgage insurance premiums paid during the year, which may qualify to be treated as deductible mortgage interest.

Understanding the power of your mortgage interest deduction to offset taxable income is a huge advantage to the American homeowner.

Happy Investing!