What is the Home Mortgage Interest Deduction
Mortgage Interest on your main home, second home, or rental property is fully deductible on your tax return. To be eligible for the mortgage interest deduction you must meet the IRS requirements for the Mortgage Interest Deduction.
Home Mortgage Interest Deduction Definition
Home mortgage interest is generally any interest you pay on a loan secured by your home (main home or second home). The loan may be a mortgage to buy your home, a second mortgage, a line of credit, or a home equity loan. The interest if fully tax deductible.
Most home buyers take out a mortgage (loan) to buy their home. They then make monthly payments to either the mortgage holder or someone collecting the payments for the mortgage holder.
You can use the home mortgage interest deduction only if you meet all the following requirements:
- You must file Form 1040 and itemize deductions on Schedule A (Form 1040).
- You must be legally liable for the loan. You cannot deduct payments for someone else if you are not legally liable to make them. Both you and the lender must intend that the loan be repaid. In addition, there must be a true debtor-creditor relationship between you and the lender.
- The mortgage must be secured debt on a qualified home.
- You deduct intererst on no more than two residences.
Fully Deductible Interest
In most cases, all of the interest you pay on a mortgage to purchase your home is fully deductible. Whether it is all deductible depends on the date you took out the mortgage, the amount of the mortgage, and your use of its proceeds.
Second mortgage interest is also included. Your home mortgage interest deduction amount is generally reported to you on Form 1098, Mortgage Interest Statement by the financial institution to which you made the payments.
Essentially, in order for home mortgage interest to be deductible, the interest you pay must be on a loan secured by your main home or a second home. The loan can be a first or second mortgage, a home improvement loan, or a home equity loan.
As with any deductible, the IRS has requirements that you must meet to use the Mortgage Interest Deduction?.
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.
Main Home. You can have only one main home at any one point in 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 which you rented the home at a fair market value. If you do not use the home long enough it is considered rental property and not a second home.
Two Residence Limit for Home Mortgage Interest Deduction
There is a two residence limit for qualifying mortgage debt. If you own more than two houses, you will need to decide which residence will be considered your second residence. The home mortgage interest on the second residence is fully deductible.
If you own more than two houses, you will have to decide which residence will be considered your second residence. Interest on debt secured by a residence other than your principal or second home may still be deductible, but only if your use the proceeds for investment or business purposes; ie a rental property.
Home Mortgage Interest Tax Credit
To encourage home ownership, the government offers certain assistance to low-income people to help them become home owners. One of these policies is to offer the opportunity to claim a tax credit for mortgage interest.
No Prepaying Home Mortgage Interest
With real estate taxes you can prepay your real estate taxes due next year and deduct them on your tax return. The rules are different with home mortgage interest. If you prepay interest for a period that goes beyond the end of the tax year, you must spread this interest over the tax years to which it applies.
You can deduct in each year only the home mortgage interest that qualifies as home mortgage interest for that year.
Mortgage Prepayment Penalty
If you pay off your home mortgage early, you may have to pay a penalty. You can deduct the penalty as home mortgage interest deduction provided the penalty is not for a specific service performed or cost incurred in connection with your mortgage loan.
Refinanced Home Mortgage Interest
If you refinance your original mortgage for an new mortgage that is greater than your original one, you cannot deduct interest “in excess” of the current balance on your original mortgage.
Mortgage Interest Deduction Example: Greg and Katie originally obtained a $250,000 mortgage to purchase their home. Several years later, their original mortgage has been reduced to $220,000. If they were to refinance their home, they would not be able to deduct interest on a new mortgage above $220,000. Assume they refinanced their home and their new mortgage was increased to $240,000. Interest on the $20,000 excess ($240,000 – $220,000) cannot be deducted.
Mortgage Interest Deduction Loan Limit
Interest is deductible up to $1 million of home acquisition loans that are taken out after October 13, 1987. The limit is $500,000 if you are married and file your tax return separately. Mortgage loans taken out before October 14, 1987 are not subject to the $1 million limit. However, any outstanding loans from before October 14, 1987, reduce the $1 million ceiling for post-October 13, 1987 loans.
Mortgage Interest Deduction Tip
Even though your home mortgage interest is tax deductible, you still want to get the lowest possible interest rate. There is no need to overextend yourself with your monthly mortgage payment.
Refund of Home Mortgage Interest
If you receive a refund of home mortgage interest that you deducted in an earlier year and that reduced your tax, you generally must include the refund in income in the year you receive it.
The amount of the refund will usually be shown on the mortgage interest statement you receive from your mortgage lender.
Late Payment Charge on Mortgage Payment
You can deduct as home mortgage interest a late payment charge if it was not for a specific service in connection with your mortgage loan.
Mortgage Interest Paid at Settlement
One item that normally appears on a settlement or closing statement is home mortgage interest.
You can deduct the interest that you pay at settlement if you itemize your deductions on Schedule A (Form 1040). This home mortgage interest deduction amount should be included in the mortgage interest statement provided by your lender.