The mortgage interest tax deduction (interest deduction) is a benefit that may sway anyone to become a homeowner rather than a renter. This advantage is backed by the common notion that most monthly mortgage payments are interest only. Although the interest deduction is only good if you itemize on your tax return, as the largest personal tax deduction that is available to taxpayers, mortgages are large enough to contribute some value to your overall return. According to a Forbes article, average middle-class homeowners were able to save an average of about $615 over the 2012 tax season thanks to interest deductions.
If you are currently stuck with a higher interest rate from years ago and are unable to refinance, you may be able to potentially save a lot of money by itemizing on your taxes. With a $250,000 30-year fixed rate mortgage with an interest of about 6.5%, you could be able to deduct thousand of dollars a year on your tax return from the inception of your loan. Although the interest payments decrease over time, reporting this information when it comes to tax-time will ultimately help you save more.
Mortgage interest deductions are not for all borrowers and come with a variety of rules. One such rule is that some borrowers can use the deduction on all of their interest, while others cannot. The ability to use all of your interest on your tax return depends on the date of the mortgage, the amount of the mortgage, and how you use the mortgage proceeds.
If you are not sure, borrowers who meet at least one of these three qualifications can deduct all of their interest:
– Home loans that were taken out on or before October 13, 1987.
– Loans that were taken out after October 13, 1987 that were used as home acquisition debt to buy build or improve a home. These loans must have a principle of under $1,000,000 ($500,000 or less if married filing separately).
– Home equity loans or lines of credit that total $100,000 or less (($50,000 or less if married filing separately) that were taken out after October 13, 1987 to buy, build, or improve your home. These loans must also not have totaled no more than the fair market value of your home reduced by (1) and (2).
If your mortgage interest expense for the year does not fit into these 3 categories, there is going to be some limits to how you can use the deduction on your tax return. When it comes time to file your taxes, you will have to submit certain information to the IRS regarding your loan. That information can be seen at this IRS link.
Types of interest that can be deducted on your taxes
A loan that counts as a secured debt can be defined as one that involved the signing of a deed of trust, a land contract or simple mortgage documents. Secured debt is a homeownership contract that verifies that you will pay off the debt, confirms that if you default on the debt that your home will act as the security for the missed payments, and protects the lender and borrower with local and state laws.
Borrowers have the right to file their qualified home as a secured or non-secured home when filing on their initial taxes. This being said, no one can just flip flop if they just feel like it. Switching a qualified home back to a secure debt during tax time indeed requires the consent of the IRS. Some borrowers may benefit tax wise to declare their mortgage as not secured, if they can benefit more from declaring the interest as a business expense. Consulting a tax professional during circumstances like this one is a must.
Under tax laws, first and second homes can be declared under the interest deduction sections of tax returns. Because a large chunk of, “mortgage,” borrowers are indeed homeowners, this allows a good portion of individuals to get as much back as they can on their taxes. First and second homes can be classified through various properties such as houses, condominiums, cooperatives, mobile homes, trailer homes, and boats.
Another thing to keep in mind is that interest for mortgages that was used for additional deductible purposes such as businesses, and investments may also be used. Mortgage funds used for personal interests other than renovations cannot be used as an interest deduction.
Specific house types and limitations that can qualify for interest deductions include:
1. Main homes
Keep in mind that only one home or the house where you live your ordinary life can be used under this category at a time.
2. Second homes
Second homes can be properties owned by you but not treated as a main home otherwise known as a primary residence. Second homes do not have to be rented out to count as a tax deduction, but if you have a second home that you rent out for only part of the year, you must use the property for your own use during 14 or more days or 10% of the year to make it qualified. If you do not use it for that long during part of the year, this rental property cannot be classified as a second home. Instead you will have to file it as a residential rental property.
3. More than one second home
Only one second home can be recorded as a qualified deduction for the year. The properties’ status can be changed if:
– The property you want to use as the deduction was just purchased.
– Your main home now qualifies as a second home.
– Your existing second home was sold during the year and you wish to maintain a second home deduction.
4. Home that has divided uses
Depending on if you use part of your home as something such as a home office, you must differentiate your primary residence from the part you are using for something else. You must then divide both the cost and fair market value of your home between the part that is a qualified home and the part that is not. This calculation may affect the amount of your home acquisition debt and your home equity debt limit.
5. Partial rental
A property can be divided between a primary residence and a rental property if:
– The tenant uses the rental section for primary living.
– The rental section is not a self-contained residential unit having separate sleeping, cooking, and toilet facilities.
– You do not sublease by renting the same or different parts of the home to over two tenants at any time during the year.
6. Home construction
Properties enduring construction for the use of a primary residence can be considered a qualified deduction for a 2 year period.
7. Destroyed homes
If destroyed by a natural disaster such as a fire, tornado, earthquake or hurricane, interest paid on the mortgage of a main or second home can still be subject to deduction if:
– The home is rebuilt
– You sell the land on which the home is located.
Mortgages that may not be deductible
Liens attached to the property without consent of the borrower such as a mechanic’s lien or a judgment lien do not qualify as interest that can be written off on tax returns. This idea is backed by the fact that such debt is not secured by the home.
A wraparound mortgage can be defined as, “A type of loan that enables a borrower who is paying off an existing mortgage to obtain more financing from a second lender or seller. The new lender (typically a bank or the seller of the real property) assumes the payment of the existing mortgage and provides the borrower with a new, larger loan, usually at a higher interest rate.”
This specialized debt can only be considered secured if mandated under state law. The reasoning behind this has to do with the circumstances of such a loan. Such an example would be where a seller doesn’t record the new mortgage if the state law dictates that they do not have to. The inconsistency of rules is the warrant for the mortgage not counting as secured debt.
The less you borrow, the more likely you are going to be able to reap the benefits of the interest deduction. This is because borrowers with a loan over $1 million are going to have a harder time getting anything back from the IRS.
VA Deductions and Benefits
As a mortgage assistance website, we at LoanSafe pride ourselves in getting information out to various types of borrowers. VA loan borrowers are another demographic who can benefit from mortgage interest deductions. VA purchasers can claim deductions on mortgage interest, discount points and origination fees.
1. Closing benefits
Veterans and service members can take advantage of numerous advantages including the ability to write off 100% of interest paid during the tax year. Discount points and origination fees can especially be advantageous due to the fact that the 4% of the mortgage paid in closing costs can be paid off by the seller if the borrower is a decent negotiator. These free fees can be written off by the VA borrower, even if the seller makes 100% of the payments.
2. VA cash-out refinance interest deduction
Performing this type of refinance typically aids borrowers to pay off the principle on debts like credit cards and first mortgages. This not only helps to reduce the principles, but to gain the interest reduction on their tax returns as well. A significant gain from using these loans however is getting the interest payments on some credit cards that rank in 20% in interest payments lowered; As well as lower the interest payments on already low mortgage rates which run around 3.5% these days.
3. Living in a home tax free
By being married and living in the home for 2 years, a couple can sell a home for up to $500,000 and avoid the taxes. This process can be done over and over again without any repercussions. Singles can equally sell a home for up to $250,000 with an identical tax break.
A requirement for this sale type is that the property must have been a primary residence. This tax deduction is a huge financial benefit for VA loan borrowers.
For more information on tax write-offs that service members can tax advantage of, be sure to contact a tax specialist.
Some common tips to remember about interest write-offs are:
– Keeping track of the interest that you pay can be easy due to the constant statements that are available these days through the computer and traditional letters.
– Try and stay up-to-date with mortgage laws. Tax write-offs and other factors that deal with the borrowers market are currently hot topics in the political realm. Staying on top of law changes may save you financially in the long run.
– Using mortgage calculators to make these calculations can be helpful. LoanSafe for example has a variety of loan calculators including one that helps to determine the savings between a fixed or interest only loan. Our calculators can be found on our homepage.
Plenty of other situations where mortgage borrowers can and can’t use their interest as a deduction on their tax filings can be found from the IRS at this link.