The home mortgage interest deduction is one of the most common and popular deductions reported by individuals on their personal income tax returns. There are various rules that must be adhered to in computing the mortgage interest deduction. An excellent source of information on this subject is IRS Publication 936, which can be found here.

A homeowner can deduct mortgage interest paid on a loan secured by either their principal residence or one secondary residence (qualified home). The definition of a residence includes stock in a cooperative housing corporation owned by a tenant-stockholder, often referred to as a co-op apartment. A boat can also qualify as a residence as long as it has a kitchen and sleeping facilities. If a taxpayer owns more than two residences, only one of the secondary residences can qualify for a home mortgage interest deduction, even if the taxpayer has no mortgage on their principal residence. A deduction cannot be claimed when a loan is taken out on one residence and the borrowed funds are used to purchase or construct a different residence.

The home mortgage interest deduction has two components – home acquisition debt and home equity debt. Home acquisition debt is a mortgage taken out after October 13, 1987 to buy, build, or substantially improve a qualified home. The total amount that can be treated as home acquisition debt is limited to $1 million. Home equity debt is a mortgage also taken out after October 13, 1987 that is used for reasons other than to buy, build, or substantially improve a qualified home. The total amount that can be treated as home equity debt is limited to $100,000. The aforementioned $1 million and $100,000 limitations apply to taxpayers filing as single, married joint, and as head of household. These limits are cut in half to $500,000 and $50,000 respectively for taxpayers filing under the married separate status.

The significance of the October 13, 1987 date referenced above is that a mortgage taken out before October 14, 1987 is defined as “grandfathered” debt and has no limitation. Any refinanced grandfather debt after October 13, 1987, for an amount not greater than the mortgage principal remaining on the debt, will continue to be treated as grandfathered debt.

Another item to be aware of when computing the home mortgage interest deduction is the payment of “points”, often referred to as loan origination fees or loan discount fees. These are charges paid by a borrower to obtain a home mortgage. Points can be deducted in the year paid if a number of tests are met. These include the loan being secured by the borrower’s principal residence, the points being computed as a percentage of the principal amount of the mortgage, and the amount clearly showing on settlement statement such as Form HUD-1. Points paid on a secondary residence, or in connection with a refinancing, cannot be deducted in the year paid but instead are deductible ratably over the life of the loan.

The IRS closely scrutinizes the home mortgage interest deduction. Numerous desk audits have been conducted when the IRS believes the deduction claimed may be excessive. Taxpayers are asked to provide copies of deeds, loan agreements, and statements documenting beginning and ending mortgage principal balances so that the IRS can determine the accuracy of the calculated home mortgage interest deduction.

Various members of Congress have recommended that the home mortgage interest deduction be scaled back. There has also been talk of either reducing the mortgage balance thresholds or no longer allowing a deduction for home mortgage interest paid on a secondary residence. Despite this talk, there have been no changes to the home mortgage interest deduction rules since 1987.

Neil Becourtney, CPA

CohnReznick LLP