If you were one of the many Americans who eagerly bought homes with a “no income verification” mortgage or borrowed against your home’s line of equity and now plan on deducting mortgage interest that seems too large for your income the IRS might become very interested in your tax returns.  It is only logical that anyone who pays a certain amount of mortgage interest should also be reporting an income that is large enough to support that payment as well as other living expenses. 

The IRS is going to start paying closer attention to Form 1098, which details the total amount of mortgage interest paid in a tax year, which could uncover many people who were not reporting their full income or not filing an income return at all.

When the IRS audits an individual they will typically dig back a few years worth of records.  With the exotic mortgages that were widely accepted earlier in this decade it is possible that many honest taxpayers were actually filing their taxes on time but not up to the IRS’ standards.  There are a few ways that you can help your situation if the IRS does come looking for you because they think you are claiming interest deductions that are too large for your income.

Keeping records is the best way to help your case should the IRS come looking to audit you.  If you have a legitimate reason for reporting a mortgage interest that seems too large for your income it is important to keep accurate records of any instance that may be associated with this.  For example if you regularly received a check from a family member as a gift that allowed you to make such large mortgage payments then it is important to keep documentation of that gift.

It is also important that you deduct correctly.  There are various stipulations that apply when looking to deduct the interest from your mortgage loan.  For example if you took out a loan to purchase your home then deductibility is limited to the interest charges up to $100,000. 

However, if you took out a loan to be used for home improvements then you may also deduct the interest in excess of $100,000.  It is important that you understand what amounts can be deducted when you take out a loan from your house so that you can show the IRS that you were doing your taxes correctly.

Lastly, you will want to compare yourself to other individuals that the IRS might find of interest.  While the IRS does not provide specifics on how and when it will pursue audits it is more likely that the IRS will pursue nonfilers and under reporters through mortgage data. 

The IRS is much less likely to go after any people who have committed minor violations of home equity deductability.  While you are still not in the clear from the IRS you will certainly have much less to worry about.

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