Home Mortgage Deductions

From the Desk of Michael T. McCormick

Home Mortgage Deductions

The deduction for home mortgage interest is one of the most potent tax breaks available to you today. And there is more involved than just a tax break that cuts the cost of home ownership. The home mortgage interest deduction also can turn what normally would be a nondeductible expense into a legitimate deduction. Because the potential for tax savings is so great, it may be useful for us to review the rules. As you’ll see, they are quite complex and full of pitfalls as well as opportunities. That’s because they depend on your reason for getting a home mortgage or home equity loan.

For home buying: Like the vast majority of Americans, you usually can fully deduct the interest paid on a loan if the proceeds are used to buy or build a residence (a main home and one vacation home). This type of financing is called acquisition debt; it can’t exceed an aggregate of $1.1 million for all interest to be deductible, and must be secured by your home. In most situations, you also will be able to fully deduct any points you pay to the lender in the year you get a mortgage loan to buy your main residence. Maximizing the potential for tax savings often is a challenge. For example, suppose you’re selling a home in which you have substantial equity and buying another one. Is it better to use all of the cash you net on the sale as a down payment and get a small mortgage (and small deductions) on the new home? Or you should invest the cash elsewhere, possibly in a tax-favored vehicle, and get a larger mortgage that yields fully deductible interest?

For home remodeling: If you refinance your existing loan to pay for an expansion or remodeling of your home, all of the interest you pay on the new loan usually will be deductible as acquisition debt. Here, the decision-making process often involves financial as well as tax considerations. Are you better off refinancing your existing loan or getting a second mortgage or a home equity loan? How many points will you pay on the new loan? Will you pay for the points at the loan closing or will you finance this charge over the loan term? If you remodel your main home, when you’ll be able to deduct the points charged depends on the ratio of the remodeling cost to the total amount of the new mortgage, and on the method of payment for the points.

Refinancing for better rates: If you pay off the loan you got to buy your home with a new loan carrying a lower rate of interest (or more favorable terms overall), all of your interest on the loan usually will be deductible as acquisition debt. Any points you pay on the new loan will be deductible over the loan term.

Refinancing or home equity loan to raise cash: You can’t deduct the interest you pay on a consumer loan to pay for a personal asset or expense, such as buying a new car, or paying medical expenses. However, you can transform that nondeductible expense into fully deductible interest if you use your home as collateral for the loan, and the total amount of such home-equity debt doesn’t exceed $100,000. The loan can be a first mortgage, a second mortgage, or a home equity type loan. The type that is right for you will depend on factors such as how much you’ll pay in closing charges (including points), how much interest you’ll pay, and the size of your outstanding home loan amount.

Please do not hesitate to give us a call and we’ll set up an appointment to analyze your home financing situation and your cash needs. Then we’ll be in a position to show how you can cut overall financing costs and make the most of the home mortgage interest deduction.