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5 facts you should know about mortgage-interest tax deductions

Posted on April 15 By Peter Andrew

Tax planning is a complicated business, and it's not possible to describe in a short article all the different rules that apply in every situation. If you'd like more information on points raised below, please visit Publication 936 on the IRS's website.

1. Interest deductions on home loans aren't for everyone

According to the Tax Policy Center, only about 30 percent of American taxpayers itemized their deductions in 2010, the rest preferring to claim their standard allowance. True, you might think that homeowners are more likely than average to itemize, but that figure means that many (maybe most) don't -- and therefore don't deduct their mortgage loan interest.

That may sound like madness, but -- at least for those on lower and average incomes -- it may actually make sense. Bloomberg reported last December that, in 2011, "the average benefit [of deducting mortgage interest] for a middle-income earner was $139." The article went on to say that the same figure that year for those in the top 1 percent was $3,752, so the advantages of itemizing seem to increase with wealth.

2. You may be able to deduct for two mortgage loans

If you've been promising yourself a lakeside cabin or beachfront house as a second home, you may want to make your purchase. That's because your dream may be more affordable than you thought possible: you may well qualify to deduct mortgage interest on your vacation property -- even if it's a timeshare and/or if you rent it out for much of the year.

The key rules are:

  1. For tax purposes, you're only allowed to designate one property as your main home, and one other as your second home.
  2. If you rent out your second home for any purpose, you must spend at least 10 percent of the rental days each year living in it yourself, with a minimum of 14 days no matter how long the rental period. If you don't rent it out at all, you don't have to spend any time there.
  3. There are circumstances in which you can change your designated second home during a tax year.

3. You can claim for points

Some of the mortgage loan costs you incur when you buy or build your home are usually deductible. These "points" generally fall into two categories:

  1. Mortgage loan origination fees, and maximum loan charges. If your lender inflates these, perhaps to cover other costs such as appraiser's or notary's fees, the IRS may question their eligibility as deductibles.
  2. Loan discount or discount points. These are upfront payments that buy you lower ongoing mortgage rates.

Sometimes points can be deducted in full during the year you make your purchase, but the IRS lists nine rules that have to be complied with in order for that to happen. If you can't meet those requirements, your deductions for points should normally be spread over the lifetime of your mortgage loan.

Amazingly, points can be deducted by the buyer, even if he or she is lucky enough to have them paid by the seller.

4. You can sometimes deduct mortgage insurance premiums

The IRS regards qualified mortgage insurance premiums as home loan interest. So it's usually deductible, providing:

  1. Your mortgage insurance contract is dated after 2006.
  2. Your adjusted gross income (AGI) is less than $109,000 (or $54,500 if you're married and filing separately). Those figures apply to 2013 filings for the 2012 tax year. The amount deductible starts to tail off at a $100,000 AGI, and reaches zero at $109K.

"Funding fees" on VA mortgages and "guarantee fees" on Rural Housing Service loans count as mortgage insurance premiums.

5. You may be able to deduct home equity loan interest

The IRS talks about qualified mortgage loans as being used "to buy, build, or substantially improve your home." However, within certain rules, you may also be able to deduct interest on home equity debt that was taken on for other reasons, always providing it's secured by your qualified home.

Many readers may decide that none of the above makes it worth their while to itemize their deductions. However, if you think your potential savings could outweigh the hassle, why not consult a professional adviser or carry out some further research yourself?

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