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Understanding the Mortgage Interest Tax Credit

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Mortgage interest tax credit is a significant benefit for homeowners. If you have taken a mortgage to purchase, build, or substantially improve a primary or secondary home, you may be eligible for a deduction on the interest you pay. In this article, we will deep-dive into the subject and provide you with comprehensive knowledge about how this credit works, how to qualify for it, and how it can benefit you.

What is Mortgage Interest?

Before we delve into the details of the mortgage interest tax credit, it's crucial to understand what mortgage interest is. When you take a mortgage loan to buy a house, a condominium, a cooperative, a mobile home, a boat, or a recreational vehicle used as a home, you are required to pay interest on that loan. This interest is what is commonly referred to as mortgage interest.

The Benefit of Mortgage Interest Deduction

The Internal Revenue Service (IRS) allows homeowners who itemize their tax deductions to deduct the interest they pay on a mortgage for their main home or a second home. There are some restrictions, but in general, the mortgage interest deduction can significantly reduce your taxable income, potentially saving you thousands of dollars.

Types of Loans Eligible for the Deduction

Mortgage interest deduction applies to specific types of loans. These typically include:

  • A mortgage to buy or build your home

  • A second mortgage

  • A line of credit

  • A home equity loan

To qualify for the deduction, the loan must be a secured debt on your main or second home. Personal loans or loans secured by a third or fourth home are not eligible for the deduction.

The Concept of a Home for IRS

For tax purposes, the IRS considers a wide range of properties as homes. These include houses, condominiums, cooperatives, mobile homes, trailers, motor homes, boats, recreational vehicles, or similar properties that have sleeping, cooking, and toilet facilities.

Taking the Deduction as the Primary Borrower

If you are the primary borrower, you are legally obligated to pay the debt, and you actually make the payments, then you are eligible to take the mortgage interest deduction. If you are married and both you and your spouse sign for the loan, then both of you are considered primary borrowers. However, if you pay your child's mortgage without being a co-signer on the loan, you cannot deduct the interest.

Limits on Deduction

The IRS imposes limits on the amount of mortgage interest you can deduct. For loans secured after October 13, 1987, and before December 16, 2017, the limit was $1 million ($500,000 if married filing separately). For loans secured after December 15, 2017, the limit has been reduced to $750,000 ($375,000 if married filing separately). These limits apply to the combined mortgages on your main home and second home.

Special Circumstances

In certain special situations, the rules for mortgage interest deduction may vary.

If you have a second home that you rent out for part of the year, you must use it for more than 14 days or more than 10% of the number of days you rented it out, whichever is larger, for it to be considered a second home for tax purposes.

If you own rental property and borrow against it to buy a home, the interest does not qualify as mortgage interest because the loan is not secured by the home itself. Interest paid on such a loan cannot be deducted as a rental expense either.

Importance of Record Keeping

To claim the mortgage interest deduction, you need to keep detailed records. These include copies of Form 1098: Mortgage Interest Statement, your closing statement from a refinancing, and your federal tax return from last year if you refinanced your mortgage last year or earlier.

Refinancing and Mortgage Interest

When you refinance a mortgage that was treated as acquisition debt, the new mortgage is treated as home acquisition debt up to the balance of the old mortgage. The excess over the old mortgage balance not used to buy, build, or substantially improve your home might qualify as home equity debt.

Wrapping up

Understanding the mortgage interest tax credit is key to maximizing your tax savings as a homeowner. Always consult with a tax professional to make sure you're taking full advantage of this and other tax benefits.


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