Deducting Mortgage Interest
Most homeowners have heard about the changes Congress made to the home mortgage interest-deduction rules that became effective for the 1988 tax year.
But there is still considerable confusion about which interest is immediately deductible, what must be deducted over the life of the home mortgage and which interest is not deductible as residence interest.
Home buyers who purchased their primary or secondary personal residence after Oct. 13, 1987, can fully deduct interest on their “acquisition mortgage” financing up to $1 million.
Such financing includes home loans secured by the residence that are used to buy, build or substantially improve the owner’s home.
Interest on pre-Oct. 13, 1987, home mortgages is “grandfathered” and considered to be an acquisition mortgage. Similarly, refinancing of such pre-Oct. 13, 1987, loans also qualifies as acquisition mortgage if the new amount does not exceed the old loan’s balance.
Funds borrowed and secured by your principal or second home within 90 days before or after acquisition are considered acquisition debt.
This means that if you paid cash for your new home but later change your mind and obtain a home loan within 90 days after purchase, you can deduct the mortgage interest on acquisition debt up to $1 million.
If you paid a loan fee, often called “points,” to obtain an acquisition mortgage from a lender who customarily charges such fees, the loan fee is deductible as itemized interest if you paid the loan fee by separate check and did not let the lender subtract it from the loan proceeds.
However, if you did not pay the loan fee by separate check to the lender, then the loan fee must be amortized (deducted) over the life of the mortgage. To illustrate, if the lender subtracted a $1,000 loan fee for your 30-year loan, you can deduct $33.33 each year for the next 30 years.
According to the Tax Court that ruled in the recent Huntsman case, loan fees paid to obtain refinancing to pay off a balloon payment home-acquisition mortgage are tax-deductible over the life of the mortgage and cannot be fully deducted in the year of obtaining the refinanced mortgage.
In addition to deducting interest on acquisition debt, homeowners can deduct interest on up to $100,000 of home-equity debt secured by the residence, regardless of the loan’s purpose.
However, interest on loans secured by residences exceeding their market value are not deductible.
This rule prevents homeowners from over-financing by converting non-deductible consumer debt, such as an auto loan, into a deductible home-equity loan.
For purposes of deducting qualified residence interest, IRS Temporary Regulation 1.163-10T(p) defines a residence as a house, condominium, cooperative apartment, mobile home or boat that provides basic living accommodations, including sleeping space, toilet and cooking facilities.
It can be the owner’s principal or secondary residence. However, if a secondary residence is rented to tenants during part of the year, to qualify, the owner must use it for personal purposes for the greater of at least 14 days, or during 10% of its rental days. Otherwise, it does not qualify as a secondary residence.
If you are building a new home with help from a construction loan, the construction loan interest is fully deductible if paid within 24 months before the home is finished and occupied.
But the $1-million acquisition debt ceiling also applies to home construction loans. You have up to 90 days after construction completion to obtain an acquisition mortgage to replace the construction loan.
