THE HOME MORTGAGE INTEREST DEDUCTION

With limits that will be discussed below, all interest which a homeowner pays on his or her mortgage is deductible from his or her federal and state income taxes. This home mortgage interest deduction is extremely important for several reasons. First, for most taxpayers, this is one of the largest single deductions available to them. Second, the continuing availability of this deduction has a tremendous impact on the real estate market.

The statutory basis of this deduction is 26 United States Code Section 163(h). The Internal Revenue Service’s website giving general information to the public is http://www.irs.gov/. A detailed explanation of this deduction is set forth at http://www.irs.gov/pub/irs-pdf/p936.pdf.

The basic rules are as follows. The deduction applies to any interest paid on a loan, which is secured by your main home or second home. The loan can be a mortgage, a second mortgage, a line of credit or a home equity line. As long as you are legally liable for the loan, and it is secured against your home, the deduction applies. (The deduction, however, applies only to voluntarily created secured loans, such as mortgages. If you have involuntary liens against your house, such as mechanic’s liens, the deduction does not apply.)

Prior to 1986, the deduction was unlimited in amount. In 1986, however, Congress capped the total, which can be deducted. The current rules are as follows:

- You can deduct an unlimited amount of home mortgage interest on mortgages created on or before October 13, 1987.

- As to loans created after 1987, as long as you used them to buy, build or improve your home, all of the interest paid is deductible, up to a total of one million dollars in principal amount ($500,000 if you are married and filing separately).

- As to loans created after 1987, not used to buy, build or improve your home, all the interest paid is deductible, up to a total of $100,000 in principal amount ($50,000 if you are married and filing separately).

- The totals apply to all of your home loans. You do not get one million per house. You get one million total on both houses, if you have two houses.

You can deduct all interest paid, within these limits. In addition, you can deduct late charges and prepayment penalties, as long as they are not for any specific services rendered by the lender.

These rules apply both to your main home and your second home, if you have one. “Home” is defined expansively. It includes houses, condominiums, cooperatives, mobile homes, trailers, boats and other structures, as long as they include sleeping, cooking and toilet facilities. You only get one main home. It where you live, most of the time.

If you own more than two homes, you have to elect which one of the others to count as your second home for purpose of this deduction. If you rent out your second home, this can endanger the deduction. You must use the home yourself for the longer of fourteen days in a year, or 10% more than the days the house was rented out. If you do not meet these requirements, then the house is considered a rental property, not a second home for this purpose.

Your lender should send you a Form 1098, which sets forth the amount of deductible interest, which you have paid. To get the deduction, you must file a Form 1040 and itemize your deduction

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