Introduced along with the income tax in 1913, the mortgage interest tax deduction has since become the favorite tax deduction for millions of U.S. homeowners. Here we look at the existing rules behind this deduction, as well as what its future may be in the face of proposed tax reforms.

Tutorial: Personal Income Tax Guide

Limitations
In most cases, all mortgage interest can be deducted from U.S. federal taxes, provided the homeowner meets the following requirements:

  • He or she files Form 1040 and itemizes deductions on Schedule A.
  • He or she is legally liable for the loan - you cannot deduct interest if you make a payment on someone else's loan.
  • He or she made the payment on a qualified home.

Of course, because the deductions are regulated by the government, the rules are never quite as simple as they seem at first glance. There are two types of debt that generate tax-deductible interest. The first is debt that was taken out in order to buy, build or improve your home. This type of debt is known as "acquisition debt." The second type is debt that was taken out for other purposes and is known as "equity debt" because it draws on the equity of your property. Between the two, you can take out $1.1 million in debt and deduct the full amount of mortgage interest, provided that all mortgages fit into one of the following categories:

  • Post-October 13, 1987, Debt: Interest on a mortgage taken out to buy, build or improve your home after October 13, 1987, may be fully deducted only if the total debt from all mortgages, including any grandfathered debt, amounts to $1 million or less for married couples and $500,000 or less for singles or married couples filing separately.
  • Home Equity Debt Post-October 13, 1987: Mortgages taken out after October 13, 1987, for reasons other than to buy, build or improve your home must total $100,000 or less for married couples and $50,000 or less for singles or married couples filing separately. They must also total less than the fair market value of your house minus the value of all grandfathered debt and all post-October 13, 1987, mortgage debt.

If you managed to follow that logic without getting confused, you are in good shape so far - but don't start your deductions yet. There are additional stipulations. Even if you qualify for the deduction based on the criteria outlined above, you cannot take the deduction unless your mortgage is classified as secured debt, which means that your home must serve as collateral for the debt. If it is unsecured debt, it is considered a personal loan, and the interest on it is not deductible.

The Definition of "Home"
The next hurdle that you need to cross is ensuring that your property is a "qualified home." In order to meet this definition, the property must have sleeping, cooking and toilet facilities. Items that fit this definition can include your primary residence, a second home, a condominium, a mobile home, a house trailer or a boat.

If your home is a second home, you can deduct the interest from only one second home. You must use that property at least 14 days during the year. If your second home is a rental property, you must use it more than 10% of the time that the property is rented out. If your rental property does not meet these criteria, the interest cannot be listed on Schedule A and must instead be listed on Schedule E.

Refinancing
In recent years, falling interest rates have encouraged homeowners to refinance their mortgages. Refinancing provides an opportunity to reduce monthly mortgage payments, reduce the term of the loan, or both. When refinancing is done without taking on additional debt, all interest generated by the mortgage remains tax deductible. When homeowners use their homes as a piggy bank and refinance in order to take out equity to generate spending money - that is, for reasons other than to buy, build or improve their homes - the Home Equity Debt Post-October 13, 1987, rules apply. (For more on this, read Mortgages: The ABCs Of Refinancing.)

Proving It to the IRS
In the event of an audit by the Internal Revenue Service, you will need to have a copy of Form 1098, Mortgage Interest Statement, which should be provided each year by the firm that holds your mortgage. If you pay your mortgage payment to an individual, you will need to supply the name, Social Security number and address of the mortgage holder, in addition to the amount of interest paid. (For further reading, see Surviving The IRS Audit.)

The Bottom Line
The home mortgage interest tax deduction is cherished by homeowners and despised by proponents of income tax reform. Flat-tax advocates favor the demise of this deduction, and U.S. lawmakers on both sides of the aisle have been discussing a variety of tax reform schemes that generally involve the abolition of the mortgage interest tax deduction. However, as of 2011, there is no specific plan to abolish the home-mortgage interest deduction in the near future unless the flat tax is enacted.

To learn more, check out Understanding The Mortgage Payment Structure.

Related Articles
  1. Home & Auto

    Take the Pain Out of Selling Your House – Online

    Is an online selling service really better than selling your home the old-fashioned way? It depends on what you're after
  2. Credit & Loans

    New Rules May Make It Easier to Get a Mortgage

    Fannie Mae and Freddie Mac have come to terms with lenders on how to solve mortgage disputes. This could be good news for people with lower credit ratings.
  3. Retirement

    Best Mortgage Companies Friendly to Retirees

    If you’re no longer in the workforce and need a loan to buy a home, which companies are the most welcoming? Plus, good news about qualifying for a loan.
  4. Credit & Loans

    Don't Get Overcharged for Your Mortgage

    Don't pay more for a mortgage than necessary. Here’s a quick look at the different categories and how to be sure you're getting the best deal.
  5. Taxes

    Why People Renounce Their U.S Citizenship

    This year, the highest number of Americans ever took the irrevocable step of giving up their citizenship. Here's why.
  6. Credit & Loans

    What is an Alt-A Mortgage?

    Called "liar loans" for their low documentation requirements, Alt-A mortgages were hot until the subprime crisis. Now Wall Street wants to bring them back.
  7. Home & Auto

    Rent-To-Own Homes: How The Process Works

    A rent-to-own agreement can benefit homebuyers with bad credit or insufficient funds for a down payment. Here’s how one works.
  8. Home & Auto

    7 Must-Have Real Estate Contract Conditions

    Buying a home can bury you in paperwork. But it’s worth your time to make sure your contract contains these seven important conditions.
  9. Taxes

    Taxes: H&R Block Vs. TurboTax Vs. Jackson Hewitt

    There are more and more tax services to help ease the pain of filing income taxes. Here's our take on three of the biggest.
  10. Taxes

    Confused About Estimated Tax Deadlines for 2016?

    If you run a business or have investment income, pay attention to this year's estimated tax deadlines. Here are the details, and what's new for 2016.
RELATED FAQS
  1. How do I file taxes for income from foreign sources?

    If you are a U.S. citizen or resident alien, your income (except for amounts exempt under federal law), including that which ... Read Full Answer >>
  2. How Long Should I Keep My Tax Records?

    The Internal Revenue Service (IRS) has some hard and fast rules regarding how long taxpayers should keep their tax records. As ... Read Full Answer >>
  3. Do FHA loans require escrow accounts?

    Federal Housing Administration (FHA) loans require escrow accounts for property taxes, homeowners insurance and mortgage ... Read Full Answer >>
  4. Do FHA loans have prepayment penalties?

    Unlike subprime mortgages issued by some conventional commercial lenders, Federal Housing Administration (FHA) loans do not ... Read Full Answer >>
  5. Can FHA loans be refinanced?

    Federal Housing Administration (FHA) loans can be refinanced in several ways. According to the U.S. Department of Housing ... Read Full Answer >>
  6. Can FHA loans be used for investment property?

    Federal Housing Administration (FHA) loans were created to promote homeownership. These loans have lower down payment requirements ... Read Full Answer >>
Trading Center