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Itemized Deductions from A to Z, Part 4: Deducting Mortgage Interest

This is part four in our series on Itemized Deductions. To read the rest of the series, click here. For additional information regarding 2014 tax planning, you can download our 2014 Tax Planning Guide from the Resources tab on our website.

Mortgage interest for up to two residences is deductible on Federal Schedule A. If you have a third home, the interest might be deductible as business or investment interest depending upon the use of the proceeds, which we’ll discuss later. A loan that is used to buy, improve or construct a first or second home is called acquisition debt. For loans after October 1987, acquisition debt is limited to $1,000,000 if married and filing a joint return. You might also have up to $100,000 of home equity debt that can be used for any purpose. Any interest on debt above these limits is generally not deductible. The IRS has worksheets to calculate the allowable interest deduction.

In order to qualify as mortgage interest, the debt must be secured by your residence (or second home). Secured means the lender records the mortgage on the property. So, if you decide to lend money to a child or relative on a residence, the note needs to be properly recorded in order for them to secure the deduction.

I’d like to offer a few words about points.

Lenders may charge points or origination fees. In general, if the points are charged to buy, build or improve your primary residence and paid directly to the lender they are deductible in the year paid. Points paid to refinance a current residence or purchase a second residence are amortized over the life of the loan.

Planning Tip:
If you have cash and are looking to help children or another relative, consider being their lender. The loans must be properly documented, and the IRS mandates a minimum interest rate—currently that’s approximately 1.9% for loans with maturities of 3 to 9 years. The minimum rate for loans exceeding 9 years is currently 3.12%. You can set up the note as interest-only or interest and principle. This might also present a gifting opportunity, as the loan could be forgiven over time subject to annual gifting limits.

Next time, we’ll look at investment interest.