An interesting article on when mortgage interest is tax deductible. The new tax law last year altered the landscape when it comes to the mortgage interest deduction so it is best to discuss this with your CPA when you file your taxes.
1. DO YOU ITEMIZE YOUR TAX DEDUCTIONS?
You cannot take the mortgage interest deduction if you are taking the standard deduction. In 2018, the standard deduction is $12,000 for single taxpayers, $18,000 for heads of household, and $24,000 for married taxpayers filing a joint return. Please see a CPA for details.
2. IS YOUR HOME A "QUALIFIED RESIDENCE"?
Mortgage interest is only deductible if the mortgage is attached to a "qualified residence". Taxpayers can generally deduct the mortgage interest on two qualified homes: one primary residence and one vacation home
3. IS YOUR MORTGAGE CLASSIFIED AS "ACQUISITION INDEBTEDNESS"?
Your mortgage or home equity line of credit is considered "acquisition indebtedness" if it was used to buy, build or improve a qualified residence. Generally, you can deduct the interest on mortgage balances up to $750,000 of Acquisition Indebtedness. Here are two examples:
Jane buys her $500,000 primary residence using a $400,000 mortgage. Jane would be able to deduct the interest on the $400,000 mortgage as acquisition indebtedness because (1) the mortgage was to buy a qualified residence; and (2) the mortgage falls within the $750,000 limit.
Janice buys her $500,000 primary residence with cash. A year later, Janice does a cash-out refinance and puts a $400,000 mortgage on the home. The funds are not used for home improvements. Janice would NOT be able to deduct the interest on the new $400,000 mortgage because the funds were not used to buy, build or improve the house.
PITFALLS TO AVOID
As you can see, it's very important to structure your mortgage in a way where it can be classified as "acquisition indebtedness"! Here are a few common mistakes that many people make when choosing a mortgage strategy and deducting their mortgage interest:
Pulling cash out of a primary residence to buy a vacation home, and then illegally deducting the interest on that cash-out mortgage (in these cases, it's often better to place a mortgage on the vacation home itself so that it can be classified as "acquisition indebtedness")
Paying cash for a home, taking out a mortgage later on, and then illegally deducting the interest on that cash-out mortgage
Illegally deducting the interest on mortgage balances that do not qualify as acquisition indebtedness.