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Mortgage Interest Deductions

Updated on July 14, 2016
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Mortgage Interest Deduction Rules

This article will discuss the “personal” home-mortgage interest deduction. The personal home-mortgage interest deduction is one of the most talked about “itemized deductions.” However, it is often one of the most misunderstood itemized deductions. For many individuals, the assumption is that if you pay mortgage interest that somehow this interest will 100% positively reduce one’s taxes. However, for many people that is just not the case. In order to take the personal home-mortgage interest deduction you must first make sure that you are actually itemizing your deductions. For many people, especially those filing married filing joint, you may find that your standard deduction is so large that you do not itemize at all and therefore get no benefits from payments on your mortgage interest and/or property taxes. For others, they do not understand why not all of their mortgage interest payments are deductible even when they know for a fact they are itemizing. This could occur because the size of the mortgage is too large. The total amount that one can treat as home acquisition debt at any time on the main home or second home cannot be more than $1 million ($500,000 if filing as married filing separately). As such, only the interest payments relating to the first $1 million of secured debt will count towards the deduction. Additionally, there are limitations on the ability to take deductions on home equity lines of credit. However, I will not be discussing home equity lines of credit or their deductions in this article. For the remainder of this article I will discuss some of the requirements that one needs to meet in order to take this deduction so that taxpayers may better understand why they may or may not get any benefit from paying mortgage interest on a main or second home. I will also discuss who gets the deduction if there is more than one owner of the main or second home.

Income Tax Form

Income Tax Income Return Form And Instructions Stock Photo
Income Tax Income Return Form And Instructions Stock Photo | Source

Requirements to take the Deduction:

Secured Debt: The first requirement in being able to take a mortgage interest deduction is that your mortgage is a secured debt. A secured debt is one in which you sign an instrument that makes the ownership of the qualified home security for payment of the debt. Additionally, in case the owner defaults on the loan the home can be used to satisfy the (this is most often accomplished by mortgage lenders putting a lien on the home). Lastly, a recording or otherwise perfecting of the debt based on state and local laws with the proper authorities is completed. This allows one to know whether in fact there are other liens against the home prior to offering any lending assistance.

Qualified Home: The second requirement, in order to take a home mortgage interest deduction, is at the debt must be secured by a qualified home. A qualified home is either your main home or your second home. A home can include a house, condominium, mobile home, house trailer, boat, or similar property that has sleeping cooking and toilet facilities.

Mortgage Loan Application

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Ownership or Equitable Interest in the Qualified Home: the third requirement is that you must either be liable for the actual mortgage or have an ownership interest in the qualified home. Liability for the mortgage means that you have signed on to the mortgage document itself stating that you are making yourself liable for the payments. It is not enough to merely tell another taxpayer that you will make the payments if they sign on to the mortgage documents (this is done a lot when one party has bad credit and fears that their name being placed on the documents will hurt the interest rate). Ownership interest can be either a specified legal interest, such as having your name on the deed to the home; or an equitable interest on the property. An equitable interest occurs when you are not the legal owner (usually determined by deeding of the property), however, you put yourself in a position to take on the risks of home ownership. The totality of facts and circumstances surrounding the specific home ownership situation will determine whether a homeowner rises to the level of having an equitable interest.

Payment made in the tax year: The fourth requirement, in order to take this deduction. Is that you must have made the payment for the mortgage interest during the tax year you are trying to take the deduction for. What this means is that you cannot make an advance payment for mortgage interest for interest that is not yet accrued in order to take a bigger deduction in the current year. For example, let us say that in December 2015 you get a bonus from work for $5,000. Based on the outstanding mortgage principal you determine that in the 2016 tax year you will incur $5,000 of mortgage interest on your main home. You decide that in addition to your normal monthly payments that you will add an additional $5,000 to that payment and claim that you are paying off additional mortgage interest. In this example, you would not be able to deduct any of the additional $5,000 as mortgage interest in 2015. However, you would be able to deduct the $5,000 in the 2016 tax year even though it payment was received in 2015. There is an exception for the payment of prepaid points; however, this exception will not be discussed in this article.

Who can take the deduction? Once it has been determined that you (or multiple parties) have an interest in a qualified home that has a debt secured by the qualified home we need to look at who gets to take a deduction. The basic rule is you get to take the deduction if you are the one who actually made the payment. This is important if you have multiple owners in a property and none of the owners is married. This is because if you make the payment you cannot do a shifting of the tax deductions in order to help another co-owner.

Another issue, which catches people off guard, concerns gift payments. Sometimes your parents or friends may help you out by paying your mortgage payments directly. They believe because they are paying these mortgage payments directly that they are taking on an equitable interest in the property and therefore should take the mortgage interest deduction. This is incorrect. The reason why it is incorrect is that they are not taking on any of the risks of home ownership. They can walk away at any time and not make themselves subject to any outstanding debts obligations. Additionally, they go into the situation knowing that they are helping the true owner of the home and have no misgivings about taking ownership of the property in the future. As such, they are really making gift payments to the owner. If you received a gift then you can treat the gift as having been received and then you making the payment.

What if payments are from a joint account?: Payments made from joint accounts of co-owners or property are usually determined to be 50/50. This is because money in a joint account are normally considered to be owned equally by both owners. However, you may need to review your state law rules on joint accounts. If per state law the joint account is considered owned 100% by each party one may be able to argue that the deduction should be other than 50/50. Especially if one party put more money in the account.

To learn more about various areas of taxation, click the articles below:

More about tax rules:

  • Gambling Loss Deductions: Gambling Loss Deductions are "itemized deductions" which may help you lower your taxable income, and therefore your tax liability. Gambling Losses may only be taken up to the amount of Gambling winnings.
  • Contributions to a Traditional IRA: Contributions to a traditional IRA "may or may not" result in a deduction to gross income. One's filing status, modified adjusted gross income, earned income, and whether they are covered under a retirement plan at work can effect one's ability to take a deduction for a contribution to a traditional IRA.
  • Student Loan Interest Deductions: Payments of one's student loan interest may result in a tax deduction based on whether the interest is on a qualifying student loan, and the taxpayer meets certain eligibility requirements.
  • Roth IRA Contributions: Contributions to a Roth IRA do not result in tax deductible savings on one's tax return. However, Roth IRA investments have other great tax benefits later on in life, such as being able to possibly take distributions from the account (both contributions and income earnings) tax free "if" the recipient meets all of the requirements.

Standard versus Itemized Deduction

Do You normally take the standard deduction or itemized deduction?

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How helpful are mortgage deductions in regards to your refund amount on your return?

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© 2016 James

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