Table of Contents
- Useful Items - You may want to see:
- Home Mortgage Interest
- Investment Interest
- Items You Cannot Deduct
- Allocation of Interest
- How To Report
This chapter discusses what interest expenses you can deduct. Interest is the amount you pay for the use of borrowed money.
The following are types of interest you can deduct as itemized deductions on Schedule A (Form 1040).
Home mortgage interest, including certain points and mortgage insurance premiums.
This chapter explains these deductions. It also explains where to deduct other types of interest and lists some types of interest you cannot deduct.
Use Table 23-1 to find out where to get more information on various types of interest, including investment interest.
936 Home Mortgage Interest Deduction
550 Investment Income and Expenses
Generally, home mortgage interest is any interest you pay on a loan secured by your home (main home or a second home). The loan may be a mortgage to buy your home, a second mortgage, a line of credit, or a home equity loan.
You file Form 1040 and itemize deductions on Schedule A (Form 1040).
The mortgage is a secured debt on a qualified home in which you have an ownership interest. (Generally, your mortgage is a secured debt if you put your home up as collateral to protect the interest of the lender. The term “qualified home” means your main home or second home. For details, see Publication 936.)
Both you and the lender must intend that the loan be repaid.
In most cases, you can deduct all of your home mortgage interest. How much you can deduct depends on the date of the mortgage, the amount of the mortgage, and how you use the mortgage proceeds.
Mortgages you took out on or before October 13, 1987 (called grandfathered debt).
Mortgages you took out after October 13, 1987, to buy, build, or improve your home (called home acquisition debt), but only if throughout 2012 these mortgages plus any grandfathered debt totaled $1 million or less ($500,000 or less if married filing separately).
Mortgages you took out after October 13, 1987, other than to buy, build, or improve your home (called home equity debt), but only if throughout 2012 these mortgages totaled $100,000 or less ($50,000 or less if married filing separately) and totaled no more than the fair market value of your home reduced by (1) and (2).
This section describes certain items that can be included as home mortgage interest and others that cannot. It also describes certain special situations that may affect your deduction.
John and Peggy Harris sold their home on May 7. Through April 30, they made home mortgage interest payments of $1,220. The settlement sheet for the sale of the home showed $50 interest for the 6-day period in May up to, but not including, the date of sale. Their mortgage interest deduction is $1,270 ($1,220 + $50).
You received assistance under:
A State Housing Finance Agency (State HFA) Hardest Hit Fund program in which program payments could be used to pay mortgage interest, or
An Emergency Homeowners' Loan Program administered by the Department of Housing and Urban Development (HUD) or a state.
You meet the rules to deduct all of the mortgage interest on your loan and all of the real estate taxes on your main home.
The term “points” is used to describe certain charges paid, or treated as paid, by a borrower to obtain a home mortgage. Points may also be called loan origination fees, maximum loan charges, loan discount, or discount points.
A borrower is treated as paying any points that a home seller pays for the borrower's mortgage. See Points paid by the seller , later.
You generally cannot deduct the full amount of points in the year paid. Because they are prepaid interest, you generally deduct them ratably over the life (term) of the mortgage. See Deduction Allowed Ratably , next.
For exceptions to the general rule, see Deduction Allowed in Year Paid , later.
If you do not meet the tests listed under Deduction Allowed in Year Paid , later, the loan is not a home improvement loan, or you choose not to deduct your points in full in the year paid, you can deduct the points ratably (equally) over the life of the loan if you meet all the following tests.
You use the cash method of accounting. This means you report income in the year you receive it and deduct expenses in the year you pay them. Most individuals use this method.
Your loan is secured by a home. (The home does not need to be your main home.)
Your loan period is not more than 30 years.
If your loan period is more than 10 years, the terms of your loan are the same as other loans offered in your area for the same or longer period.
Either your loan amount is $250,000 or less, or the number of points is not more than:
4, if your loan period is 15 years or less, or
6, if your loan period is more than 15 years.
You can fully deduct points in the year paid if you meet all the following tests. (You can use Figure 23-B as a quick guide to see whether your points are fully deductible in the year paid.)
Your loan is secured by your main home. (Your main home is the one you ordinarily live in most of the time.)
Paying points is an established business practice in the area where the loan was made.
The points paid were not more than the points generally charged in that area.
You use the cash method of accounting. This means you report income in the year you receive it and deduct expenses in the year you pay them. (If you want more information about this method, see Accounting Methods in chapter 1.)
The points were not paid in place of amounts that ordinarily are stated separately on the settlement statement, such as appraisal fees, inspection fees, title fees, attorney fees, and property taxes.
The funds you provided at or before closing, plus any points the seller paid, were at least as much as the points charged. The funds you provided are not required to have been applied to the points. They can include a down payment, an escrow deposit, earnest money, and other funds you paid at or before closing for any purpose. You cannot have borrowed these funds from your lender or mortgage broker.
You use your loan to buy or build your main home.
The points were computed as a percentage of the principal amount of the mortgage.
The amount is clearly shown on the settlement statement (such as the Settlement Statement, Form HUD-1) as points charged for the mortgage. The points may be shown as paid from either your funds or the seller's.
If you meet all of these tests, you can choose to either fully deduct the points in the year paid, or deduct them over the life of the loan.
In 1997, Bill Fields got a mortgage to buy a home. In 2012, Bill refinanced that mortgage with a 15-year $100,000 mortgage loan. The mortgage is secured by his home. To get the new loan, he had to pay three points ($3,000). Two points ($2,000) were for prepaid interest, and one point ($1,000) was charged for services, in place of amounts that ordinarily are stated separately on the settlement statement. Bill paid the points out of his private funds, rather than out of the proceeds of the new loan. The payment of points is an established practice in the area, and the points charged are not more than the amount generally charged there. Bill's first payment on the new loan was due July 1. He made six payments on the loan in 2012 and is a cash basis taxpayer.
Bill used the funds from the new mortgage to repay his existing mortgage. Although the new mortgage loan was for Bill's continued ownership of his main home, it was not for the purchase or improvement of that home. He cannot deduct all of the points in 2012. He can deduct two points ($2,000) ratably over the life of the loan. He deducts $67 [($2,000 ÷ 180 months) × 6 payments] of the points in 2012. The other point ($1,000) was a fee for services and is not deductible.
The facts are the same as in Example 1, except that Bill used $25,000 of the loan proceeds to improve his home and $75,000 to repay his existing mortgage. Bill deducts 25% ($25,000 ÷ $100,000) of the points ($2,000) in 2012. His deduction is $500 ($2,000 × 25%).
Bill also deducts the ratable part of the remaining $1,500 ($2,000 − $500) that must be spread over the life of the loan. This is $50 [($1,500 ÷ 180 months) × 6 payments] in 2012. The total amount Bill deducts in 2012 is $550 ($500 + $50).
This section describes certain special situations that may affect your deduction of points.
When you took out a $100,000 mortgage loan to buy your home in December, you were charged one point ($1,000). You meet all the tests for deducting points in the year paid, except the only funds you provided were a $750 down payment. Of the $1,000 charged for points, you can deduct $750 in the year paid. You spread the remaining $250 over the life of the mortgage.
The facts are the same as in Example 1, except that the person who sold you your home also paid one point ($1,000) to help you get your mortgage. In the year paid, you can deduct $1,750 ($750 of the amount you were charged plus the $1,000 paid by the seller). You spread the remaining $250 over the life of the mortgage. You must reduce the basis of your home by the $1,000 paid by the seller.
Dan paid $3,000 in points in 2001 that he had to spread out over the 15-year life of the mortgage. He deducts $200 points per year. Through 2011, Dan has deducted $2,200 of the points.
Dan prepaid his mortgage in full in 2012. He can deduct the remaining $800 of points in 2012.
You can treat amounts you paid during 2012 for qualified mortgage insurance as home mortgage interest. The insurance must be in connection with home acquisition debt and the insurance contract must have been issued after 2006.
Ryan purchased a home in May of 2011 and financed the home with a 15-year mortgage. Ryan also prepaid all of the $9,240 in private mortgage insurance required at the time of closing in May. Since the $9,240 in private mortgage insurance is allocable to periods after 2011, Ryan must allocate the $9,240 over the shorter of the life of the mortgage or 84 months. Ryan's adjusted gross income (AGI) for 2011 is $76,000. Ryan can deduct $880 ($9,240 ÷ 84 × 8 months) for qualified mortgage insurance premiums in 2011. For 2012, Ryan can deduct $1,320 ($9,240 ÷ 84 × 12 months) if his AGI is $100,000 or less.
In this example, the mortgage insurance premiums are allocated over 84 months, which is shorter than the life of the mortgage of 15 years (180 months).
If you paid $600 or more of mortgage interest (including certain points and mortgage insurance premiums) during the year on any one mortgage, you generally will receive a Form 1098 or a similar statement from the mortgage holder. You will receive the statement if you pay interest to a person (including a financial institution or a cooperative housing corporation) in the course of that person's trade or business. A governmental unit is a person for purposes of furnishing the statement.
The statement for each year should be sent to you by January 31 of the following year. A copy of this form will also be sent to the IRS.
The statement will show the total interest you paid during the year, any mortgage insurance premiums you paid, and if you purchased a main home during the year, it also will show the deductible points paid during the year, including seller-paid points. However, it should not show any interest that was paid for you by a government agency.
As a general rule, Form 1098 will include only points that you can fully deduct in the year paid. However, certain points not included on Form 1098 also may be deductible, either in the year paid or over the life of the loan. See Points , earlier, to determine whether you can deduct points not shown on Form 1098.
This section discusses interest expenses you may be able to deduct as an investor.
If you borrow money to buy property you hold for investment, the interest you pay is investment interest. You can deduct investment interest subject to the limit discussed later. However, you cannot deduct interest you incurred to produce tax-exempt income. Nor can you deduct interest expenses on straddles.
Property held for investment includes property that produces interest, dividends, annuities, or royalties not derived in the ordinary course of a trade or business. It also includes property that produces gain or loss (not derived in the ordinary course of a trade or business) from the sale or trade of property producing these types of income or held for investment (other than an interest in a passive activity). Investment property also includes an interest in a trade or business activity in which you did not materially participate (other than a passive activity).
If you borrow money for business or personal purposes as well as for investment, you must allocate the debt among those purposes. Only the interest expense on the part of the debt used for investment purposes is treated as investment interest. The allocation is not affected by the use of property that secures the debt.
You can carry over the amount of investment interest that you could not deduct because of this limit to the next tax year. The interest carried over is treated as investment interest paid or accrued in that next year.
You can carry over disallowed investment interest to the next tax year even if it is more than your taxable income in the year the interest was paid or accrued.
Determine the amount of your net investment income by subtracting your investment expenses (other than interest expense) from your investment income.
Use Form 4952, Investment Interest Expense Deduction, to figure your deduction for investment interest.
Your investment interest expense is not more than your investment income from interest and ordinary dividends minus any qualified dividends.
You do not have any other deductible investment expenses.
You have no carryover of investment interest expense from 2011.
Some interest payments are not deductible. Certain expenses similar to interest also are not deductible. Nondeductible expenses include the following items.
Personal interest (discussed later).
Service charges (however, see Other Expenses (Line 23) in chapter 28).
Annual fees for credit cards.
Credit investigation fees.
Interest to purchase or carry tax-exempt securities.
Personal interest is not deductible. Personal interest is any interest that is not home mortgage interest, investment interest, business interest, or other deductible interest. It includes the following items.
If you use the proceeds of a loan for more than one purpose (for example, personal and business), you must allocate the interest on the loan to each use. However, you do not have to allocate home mortgage interest if it is fully deductible, regardless of how the funds are used.
You allocate interest (other than fully deductible home mortgage interest) on a loan in the same way as the loan itself is allocated. You do this by tracing disbursements of the debt proceeds to specific uses. For details on how to do this, see chapter 4 of Publication 535.
You must file Form 1040 to deduct any home mortgage interest expense on your tax return. Where you deduct your interest expense generally depends on how you use the loan proceeds. See Table 23-1 for a summary of where to deduct your interest expense.
|IF you have ...||THEN deduct it on ...||AND for more information go to ...|
|deductible student loan interest||Form 1040, line 33, or Form 1040A, line 18||Publication 970.|
|deductible home mortgage interest and points reported on Form 1098||Schedule A (Form 1040), line 10||Publication 936.|
|deductible home mortgage interest not reported on Form 1098||Schedule A (Form 1040), line 11||Publication 936.|
|deductible points not reported on Form 1098||Schedule A (Form 1040), line 12||Publication 936.|
|deductible mortgage insurance premiums||Schedule A (Form 1040), line 13||Publication 936.|
|deductible investment interest (other than incurred to produce rents or royalties)||Schedule A (Form 1040), line 14||Publication 550.|
|deductible business interest (non-farm)||Schedule C or C-EZ (Form 1040)||Publication 535.|
|deductible farm business interest||Schedule F (Form 1040)||Publications 225 and 535.|
|deductible interest incurred to produce rents or royalties||Schedule E (Form 1040)||Publications 527 and 535.|
|personal interest||not deductible.|
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