Owning a Home -- What’s Deductible?

Realtors are quick to point out that home ownership allows a lot of tax advantages not available to someone who merely pays rent. A homeowner can deduct points used to obtain a mortgage when buying a home, mortgage interest paid during the year, and property taxes.

To find out what is deductible when buying a home, click here. This article is about deductions during home ownership.

Your Biggest Deduction – Interest

If you have a mortgage on your home, the loan is probably "fully amortized." This means a portion of your monthly payment actually repays the debt and another portion pays the interest. After a scheduled period of time your mortgage is paid off.

If you itemize deductions using a Schedule A, the interest portion of your mortgage payment is usually tax deductible.

There are conditions.

The first condition is that your primary residence or a second home must be collateral for the loan.

Defining "Home"

Your home can be a house, co-op, condominium, mobile home, trailer, or even a houseboat. For trailers and houseboats, one requirement is that the home must have sleeping, cooking, and toilet facilities.

Even a rental can be considered a second home, provided you live in it either fourteen days out of the year or at least ten percent of the number of days you rent it for, whichever is greater.

Interest as a Tax Deduction

At the end of each year, your lender should send you a form 1098. This form tells you how much you paid in interest and points during the year. This is your deductible interest, provided you meet certain conditions.

If you obtained the loan prior to October 13, 1987, the loan is considered "grandfathered." All interest paid on grandfathered loans in a given year is fully tax deductible. After that, there are conditions, but most conditions won’t apply to most homeowners.

Home Acquisition Debt (an IRS Term)

An important IRS term is "home acquisition debt." Any first or second mortgage used to buy, build, or improve your home is considered to be home acquisition debt.

Acquisition debt can be a first or second mortgage used to buy your home. If you get a second mortgage and use it all for home improvement, that is also considered acquisition debt. If you do a "rate and term" refinance and don’t get any "cash out" – since you are just refinancing your acquisition debt – that also can be considered acquisition debt.

For any of the above types of loans that aren’t "grandfathered" -- you can still deduct all the interest -- but only if your total mortgage debt does not exceed one million dollars. For married couples filing separately, the limit is $500,000 each.

It gets more complicated with refinances and second mortgages.

Home Equity Debt (another IRS Term)

The IRS has another term called "home equity debt." Basically, this is any loan amount in excess of what was spent to purchase, build, or improve your home.

If you get "cash out" when refinancing your home, the amount in excess of your original loan amount is considered "home equity debt" – unless some of it was used for home improvement. Anything in excess of the home improvement cost is considered "home equity debt."

For second mortgages, it works the same way – anything not used to improve the home is considered "home equity debt."

For the interest to be fully deductible, home equity debt cannot exceed $100,000 and the total mortgage debt on the home must not exceed its value. This can create a problem for those using 125% loan-to-value second mortgages to consolidate debt. That portion of the loan amount that exceeds the value of your home is not tax deductible (unless you used it for home improvement).

Deducting Points When Refinancing

Points paid during refinancing must be deducted over the life of the loan. For a thirty-year loan, you divide the points by thirty and get to deduct that amount each year.

However, there is an exception.

If you did a "cash out" refinance and used some of the funds to improve your primary residence, a portion of the points are deductible in the year you paid them. That portion is related to how much of the loan was used for home improvement. If you obtained a $200,000 loan and $50,000 was used for home improvement, then one-fourth of the points are deductible in the year you obtained the loan.

Save your receipts.

Deducting Property Taxes

Most homeowners pay property taxes to a local, state or foreign government. In most cases, property taxes are deductible. They must be charged uniformly against all property in the jurisdiction and must be based on the assessed value.

Many states and counties also impose property taxes for local improvements to property, such as assessments for streets, sidewalks, and sewer lines. These taxes cannot be deducted. Local property taxes are deductible only if they are for maintenance or repair, or interest charges related to those benefits.

Impound Accounts

Many mortgages have impound or escrow accounts. The borrower’s payment exceeds the amount necessary to pay the principal and interest. The excess goes into an account used to pay property taxes, homeowner’s insurance and mortgage insurance.

When calculating your property tax deduction, don’t deduct what you pay into that account. Only deduct what is paid from the account to the taxing authority.

Limits on Deductions

You may be subject to a limit on some of your itemized deductions. For 2000, this limit applies if your adjusted gross income is more than $128,950, or $64,475 if you are married filing separately.

Certified Public Accountants

Whenever you reach a point where you begin itemizing deductions, it is best to have your tax returns prepared by a Certified Public Accountant. Internal Revenue Service rules and regulations can quickly become…confusing.



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