Home Mortgage Interest Tax Deduction

what is a mortgage interest statement

By William Perez. Tax Planning: U.S. Expert

William Perez has worked as a tax professional since 2004. He earned the enrolled agent designation by passing a comprehensive examination on federal taxes and maintains his credential by taking continuing education classes.

Taxpayers who itemize their deductions will need to file the Form 1040 long form.

Source Documents

  • Form 1098, Mortgage Interest Statement from your mortgage lenders.
  • HUD-1 Settlement Statement from your escrow company if you bought or sold a home.

Relevant IRS Forms and Publications

Qualifying for the Mortgage Interest Deduction

Mortgage interest includes interest you paid on loans to buy a home, home equity lines of credit, and construction loans.

That amount you can deduct is limited. You can only deduct interest paid on your main home and a second home. Interest paid on third or fourth homes, for example, is not deductible.

You need to meet the all the following requirements in order to deduct your mortgage interest:

  • 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 you make 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 a secured debt on a qualified home.
--Source: IRS Publication 936

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Secured Debt

The mortgage loan must be secured by your home in order for the interest to be tax-deductible. The mortgage must:

  • Make your ownership in a qualified home security for payment of the debt,
  • Provide, in case of default, that your home could satisfy the debt, and
  • Be recorded or otherwise be perfected under any state or local law that applies.
--Source: IRS Publication 936

Qualified Home

The mortgage must be secured by a "qualified home" in order for the interest to be tax-deductible. A qualified home is your main home or your second home. If you own more than two personal residences, you should be working with an experienced tax professional to calculate the optimal amount of mortgage interest to deduct. "A home includes a house, condominium, cooperative, mobile home, house trailer, boat, or similar property that has sleeping, cooking, and toilet facilities," according to IRS Publication 936.

Recordkeeping

You should receive a Form 1098, Mortgage Interest Statement, from each mortgage lenders. This form reports the total interest that you paid during the tax year. You do not need to attach these to your return, since the financial institution sends a copy of Form 1098 directly to the IRS. Make sure that the mortgage interest deduction you claim on Schedule A matches the amounts reported on Forms 1098. The amount you can deduct may be less than the amount you paid, based on limitations of the mortgage interest deduction. Keep Form 1098 and worksheets used to figure your deduction with your copy of your tax return for at least three years from the date your filed your return.

Dollar Limitations for the Mortgage Interest Deduction

The amount of mortgage interest you can deduct each year is limited. There is one limit for loans used to buy or build a residence -- called "home acquisition debt." And there is another limit for loans not used to buy or to build a residence -- called home equity debt. All loans, whether secured by your main home or your second home, are subject to the same overall limitations.

Home Acquisition Debt

You may not deduct interest on more than $1,000,000 of home acquisition debt for your main home and secondary residence. Home acquisition debt means any loan whose purpose is to acquire, to construct, or substantially to improve a qualified home. The limit is reduced to $500,000 if you are married filing separately .

For example, you borrowed $800,000 against your primary residence and $400,000 against your secondary residence. Both loans were used solely to acquire your residences. The loan amounts add up to $1,200,000. Since your loan amount exceeds the $1 million limit for home acquisition debt, your mortgage deduction is limited. Let's say both loans have a fixed interest rate of 6% and your total interest paid for the year was $72,000. You would only be able to deduct $60,000, which is the interest on the first $1 million of home acquisition debt. Use the worksheet in Publication 936 to calculate your allowable mortgage deduction.

Home Equity Debt

You may not deduct interest on more than $100,000 of home equity debt for your main home and secondary residence. Home equity debt means any loan whose purpose is not to acquire, to construct, or substantially to improve a qualified home, or any loan whose purposes was to substantially improve a qualified home but exceeds the home acquisition debt limit. The home equity debt limit is reduced to $50,000 if you are married filing separately. Your deduction for home equity interest may be reduced even below the $100,000 limit if your indebtedness exceeds the fair market value of your home. See the "home equity debt" section of IRS Publication 936.

Interest paid on home equity debt is an adjustment for the Alternative Minimum Tax (AMT). You should understand whether you will be able to deduct interest on a home equity line of credit before your borrow. You can figure the AMT adjustment for home equity debt using the Home Mortgage Interest Adjustment Worksheet in the Instructions for Form 6251 (pdf).

For example, you borrowed $300,000 in a home equity line of credit, and the amount you borrowed did not exceed the fair market value of your house. You used $150,000 to add a new family room to your house. You spent the remaining $150,000 to pay for college tuition. Half of the loan is treated on home acquisition debt (the amount used to substantially improve your home). The other half is treated as home equity debt (the amount not used to improve your home). You would be able to deduct interest only up to the $100,000 limit on home equity debt portion of the loan. Assuming you paid $21,000 interest on the loan, the amounts you can deduct would break down like this:

$10,500 - Fully deductible home acquisition debt (half the loan)

$7,000 - Deductible home equity debt (two-thirds of the home equity portion of the loan)

$3,500 - Non-deductible home equity debt (the interest paid on the home equity debt exceeding $100,000)

In addition, this taxpayer would have to report $7,000 as an AMT adjustment on Form 6251.

Jointly Held Mortgages

You are entitled to deduct only the interest that you paid, regardless of which person receives Form 1098 for the joint loan. The IRS provides specific instructions for deducting interest not reported to you on Form 1098 and for allocating interest among two or more borrowers. See the "How to Report" section of IRS Publication 936.

Co-borrowers who make payments to prevent foreclosure can deduct the interest paid, even if the interest was supposed to be paid by someone else. The editors of JK Lasser's Your Income Tax pass along this inside tip:

"The Tax Court has allowed a joint obligor to deduct his or her payment of another obligor's share of the mortgage interest if the payment is made to avoid the loss of property, and the payment is made with his or her separate funds." (page 328)

Home Construction Loans

You can deduct interest on mortgages used to pay construction expenses. The proceeds must be used to acquire the land and for construction of the home. Expenses incurred in the 24 months before construction was completed counts toward the $1,000,000 limit on home acquisition debt.

Note that if you deduct interest on a construction loan for two years and then decide to sell the property rather than to use it as a residence, you may have to restate your returns for the years you deducted the interest and recharacterize the interest as investment interest, which may limit its deductibility. In other words, the IRS may want some money back.

Points

Points paid on acquisition debt for primary and secondary residences are fully deductible in the year they are paid. However, points paid on refinancing must be amortized over the life of the loan. See the "points" section of Publication 936. Points may not always be reported on Form 1098, Mortgage Interest Statement, from the lender. In some cases you may find points reported on your HUD-1 closing statement.

When to Seek the Help of a Tax Professional

For most taxpayers, figuring out the home mortgage interest deduction is straight-forward. Add up the interest paid as reported to you on Form 1098, and put that total on your Schedule A. However, it is always a good idea to check with a tax professional if you bought or sold property during the year. In fact, it would make sense to seek the advice of a tax pro before you buy or sell real estate, so you can get a handle on the tax consequences of your decision.

Source: taxes.about.com

Category: Forex

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