While the IRS does allow you to deduct the interest which you pay to your lender, there are a few limitations with respect to the actual amount you can deduct.
Limitations on Interest Tax Deductions
- Type of Mortgage Loan: The IRS classifies mortgage loans into two types, both with separate limits on the base amount for which interest can be deducted.
- Home Acquisition Loan – Any loan which is used to construct, buy, or improve a qualifiedhome substantially is classified as a home acquisition loan. The maximum amount of interest you can deduct is for a loan amount of $1,000,000. If the amount of your loan exceeds this amount, the amount of tax deduction will still be limited to the one million dollars.. As long as the loan amount is lower than a million, the interest on such loans is fully deductable.
- Home Equity Loan – Any loan which allows access to the equity present in the house. The loan amount not used to fund the purchase of a new house or the improvement of a currently owned house is generally considered a home equity loan. The limit for such a loan for purposes of deductible interest is $100,000 – i.e. only the interest rate for the first $100,000 is tax deductable. The limit may be lowered further if the fair market value of your house is lower than your indebtedness. (NOTE: When the Alternative Minimum Tax is calculated, home equity loan interest rate is not an available deduction!). Additionally if you use half of your loan amount for home improvements and the other half for other reasons, the interest paid on the first half will be fully deductible, only the second half will be limited.
The above stated limits for both loans is the maximum limit for all loans on all properties – i.e. if you have taken out two loans of $700,000 one on you primary and the second on your secondary property, the total loan amount will be calculated as $1,400,000, so you will still be able to deduct on taxes for the interest on the first million alone.
- Joint Mortgage Loans: In joint mortgages, you are allowed to deduct only for that which you have paid (regardless of who receives the mortgage interest statement from the lender). Specific instructions on how to report the interest paid by you is available in Publication 936 of the IRS (check the section titled How to Report). If you are a married couple, filing for tax returns separately, then the limit for both home acquisition and home equity loans is reduced by 50% – i.e. $500,000 for home acquisition and $50,000 for home equity loans (Additionally if you make a payment for someone else to prevent a foreclosure, then the interest on that amount can also be deducted!).
- Points: Points paid for an acquisition loan are fully deductable (only in the year in which they are paid) Usually such payments are amortized over the span of the loan, so check with your lender and also have a look at the Points section in the IRS publication 936.
At the end of the day, filing for tax deductions on your mortgage interest rate is a straightforward process. But if you feel that you need extra help then you can contact a tax professional to help you.
Lender Tip: We’re not tax attorneys and this isn’t professional tax advice. But if you want advice on getting a home loan to help you maximize the interest deductions, call us.