Do you own a home, or are you looking to purchase one? Although homeownership will add to your tax obligations, there are also several tax benefits that come with being a homeowner, such as the Homestead Exemption and the Home Mortgage Interest Deduction. The Home Mortgage Interest Deduction is available to homebuyers who itemize deductions on their tax return and have a secured mortgage on a qualified home.
What counts as a qualified home?
A qualified home may be a house, condominium, cooperative, mobile home, house trailer, boat, or other property with sleeping, cooking, and toilet facilities.
Typically, a qualified home is the taxpayer’s primary residence, but a second home may also qualify in certain situations:
A second home that is not rented out may be treated as a qualified home even if you do not use it during the year.
If you own a second home and rent it out during the year, it only qualifies for the deduction if you also live there for more than 14 days or more than 10% of the number of days that it is rented during the year (whichever period is longer).
If you own more than one second home, only one may be treated as a qualified second home.
If you use part of your home for a purpose other than residential living (such as a home office), only the part used for residential living may be considered a qualified home.
If you rent out part of your home to another person, the portion being rented out may still be treated as part of your qualified home as long as the rented portion is used by the tenant primarily for residential living and is not a self-contained residential unit with its own separate sleeping, cooking, and toilet facilities. In addition, you must not rent the same or different parts of your home to more than two tenants at any time during the tax year; if two tenants (and their dependents) share the same sleeping quarters, they are treated as a single tenant.
A home under construction may be treated as a qualified home for up to 24 months, as long as it becomes your qualified home when it is ready for occupancy. This 24-month period can begin any time on or after the first day of construction begins.
If your home is destroyed in a fire, storm, tornado, earthquake, or other casualty, you may be able to continue treating it as a qualified home, barring certain limitations. Time sharing arrangements may also qualify if they meet certain eligibility requirements..
Can I deduct all of my home mortgage interest?
Most homebuyers are able to fully deduct their home mortgage interest, but how much you are eligible to deduct depends on a few factors: the date of the mortgage, the amount of the mortgage, and how you use the mortgage proceeds. You may deduct all of your mortgage interest if all of your mortgages fall into one or more of the following categories:
Mortgages taken out on or before October 13th, 1987 (“grandfathered debt”).
Mortgages taken out after October 13th, 1987, and prior to December 16th, 2017, in order to buy, build, or substantially improve your home (“home acquisition debt”), as long as these mortgages plus any grandfathered debt totaled $1 million or less if married filing jointly ($500,000 if married filing separately). An exception to this rule is made for taxpayers having entered a contract before December 15th, 2017, to close on the purchase of a principal residence before January 1st, 2018 so long as the purchase of the residence was made before April 1st, 2018; these buyers are considered to have incurred home acquisition debt prior to December 16th, 2017.
Mortgages taken out after December 15th, 2017, to buy, build, or substantially improve your home, so long as these mortgages plus any grandfathered debt totaled $750,000 or less ($375,000 or less if married filing separately).
If you have a home mortgage that does not fit into any of these three categories, the amount of interest you can deduct may be limited. If you took out the mortgage after October 13th, 2017, the amount of deductible home mortgage interest is limited to the debt that does not exceed the cost of the home plus the cost of any substantial improvements.
Can I deduct my home mortgage points?
Mortgage points are fees paid by a homebuyer directly to the mortgage lender in exchange for a reduced interest rate. Points are essentially prepaid interest that can lower a homebuyer’s monthly mortgage payments. One point is typically 1% of the mortgage amount. Even if the seller pays points at the time of sale, all points are treated as paid by the borrower for tax purposes.
Because points are prepaid interest, homebuyers generally cannot deduct the full amount of points in the year paid; instead, points must be deducted in equal portions over the life of the mortgage.
However, there are some exceptions to this rule. You may be able to deduct mortgage points in the year paid if you meet all of the following tests:
Your loan is secured by your main home.
Paying points is an established business practice in the area where the loan was made.
The points paid weren’t more than the points generally charged in that area.
You use the cash method of accounting, meaning that you report income in the year received and deduct expenses in the year paid; this is the accounting method used by most individuals.
The points weren’t paid in place of amounts that are ordinarily stated separately on the settlement statement (such as appraisal fees, inspection fees, title fees, attorney fees, and property taxes).
The funds you provided at or before closing, plus any points the seller paid, were at least as much as the points charged. These funds can include a down payment, an escrow deposit, earnest money, and other funds paid at or before closing for any purpose, as long as the funds were not borrowed from your lender or mortgage broker.
Your loan is used to buy or build your main home.
The points were figured as a percentage of the principal amount of the mortgage.
The amount is clearly shown on the settlement statement as points charged for the mortgage. The points may be shown as paid from your funds or from the seller’s.
Are my mortgage insurance payments tax deductible?
You may be surprised to learn that qualified mortgage insurance premiums can be treated as home mortgage interest. The insurance must be in connection with home acquisition debt, and the insurance contract must have been issued after 2006.
Qualified mortgage insurance includes mortgage insurance provided by the Department of Veterans Affairs, the Federal Housing Administration, the Rural Housing Service, and private mortgage insurance.
If your mortgage insurance is provided by the Department of Veterans Affairs, it is commonly referred to as a “funding fee.” Mortgage insurance provided by the Rural Housing Service is known as a “guarantee fee.” The funding fee and the guarantee fee are both eligible to be included in the amount of the loan or paid in full at the time of closing.
Note that there are income limits to this deduction; if your adjusted gross income (AGI) exceeds $100,000 (or $50,000 if married filing separately), the amount of your mortgage insurance premiums that you may deduct will be reduced or eliminated entirely.
If you have more questions on mortgage interest deductions, be sure to read through IRS Publication 936 for more information or contact your local CPA.