According to IRS Publication 936, "home mortgage interest is any interest you pay on a loan secured by your home (main home or a second home)". You can take home mortgage interest deduction as an itemize deduction on Schedule A of Form 1040 to reduce your tax liability. Here are the steps to help you figure out whether you can take home mortgage interest deduction, how much you can deduct and where to report the deductions.
Step 1: Determine whether you can take home mortgage interest deduction.
You can take home mortgage interest deduction if:
1. Your loan (debt) is "a mortgage to buy your home, a second mortgage, a line of credit or a home equity loan".
2. Your loan is secured by your main home or second home.
3. Your home is "a house, condominium, cooperative, mobile home, house trailer, boat, or similar property that has sleeping, cooking, and toilet facilities".
Step 2: Collect documents for mortgage interest deduction.
You need to collect following documents to figure the amount of mortgage interest deduction.
1. Form 1098, Mortgage Interest Statement.
You can find mortgage interest , mortgage insurance premium and points you paid during the year on this form. You should receive this form by January 31 of the following year.
2. Settlement statement from home purchase or sale.
If you purchased or sold your home during the year, you may find additional interest or points you can deduct from the settlement statement.
3. Any other document that can support your deductions.
If you paid mortgage interest , mortgage insurance premium or points or other expenses that were not reported on Form 1098, you need to collect documents that support the amount you paid with the payee's name, address and taxpayer identification number (TIN).
Step 3: Figure the amount of mortgage interest you may deduct on your return.
You may find the following deductible mortgage interest expenses from the documents you collected.
- Mortgage interest that qualifies as home mortgage interest for the year.
- Late payment charge on mortgage payment.
- Mortgage prepayment penalty for paying off your home mortgage early.
- Redeemable ground rents.
- Mortgage interest paid at settlement.
- Points paid to obtain a home mortgage.
- Points paid by the seller.
- Qualified mortgage insurance premiums.
Step 4: Check whether your mortgage interest or points deduction is limited.
1. Limits on mortgage interest deduction.
Use the table below to see if your mortgage interest deductions are limited.
If your loan fits into any of these three categories, you can deduct all your mortgage interest expenses.
If your mortgage interest deduction is limited, you can use Table 1 of Publication 936 to figure out the deductible mortgage interest.
2. Limits on points deduction.
a. Deduct points in full in the year you paid.
If you meet all the tests below, you can deduct points in full in the year you paid, or you can choose to deduct points over the life of the loan. You can also deduct points in full for points you paid on home improvement loan for your main home or points to refinance a mortgage that used to improve your main home if you meet the tests from 1 to 6.
Tests to fully deduct points in the year paid per Publication 936.
"1. Your loan is secured by your main home. (Your main home is the one you ordinarily live in most of the time.)
2. Paying points is an established business practice in the area where the loan was made.
3. The points paid were not more than the points generally charged in that area.
4. You use the cash method of accounting. This means you report income in the year you receive it and deduct expenses in the year you pay them. Most individuals use this method.
5. The points were not paid in place of amounts that ordinarily are stated separately on the settlement statement, such as appraisal fees, inspection fees, title fees, attorney fees, and property taxes.
6. The funds you provided at or before closing, plus any points the seller paid, were at least as much as the points charged. The funds you provided are not required to have been applied to the points. They can include a down payment, an escrow deposit, earnest money, and other funds you paid at or before closing for any purpose. You cannot have borrowed these funds from your lender or mortgage broker.
7. You use your loan to buy or build your main home.
8. The points were computed as a percentage of the principal amount of the mortgage.
9. The amount is clearly shown on the settlement statement (such as the Settlement Statement, Form HUD-1) as points charged for the mortgage. The points may be shown as paid from either your funds or the seller's."
b. Deduct points over the life of the loan.
If you meet all the tests below, you can deduct points over the life of the loan.
Tests to deduct points over the life of the loan per Publication 936.
"1. You use the cash method of accounting. This means you report income in the year you receive it and deduct expenses in the year you pay them. Most individuals use this method.
2. Your loan is secured by a home. (The home does not need to be your main home.)
3. Your loan period is not more than 30 years.
4. If your loan period is more than 10 years, the terms of your loan are the same as other loans offered in your area for the same or longer period.
5. Either your loan amount is $250,000 or less, or the number of points is not more than: a. 4, if your loan period is 15 years or less, or b. 6, if your loan period is more than 15 years."
Step 5: Report the mortgage interest deduction on your return.
For more information, please see IRS Publication 936, Home Mortgage Interest Deduction.
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