The federal government understands that home mortgages are the largest financial burden many Americans will face in their lives. To provide a break (and probably encourage people to participate in the real estate market), the Internal Revenue Service (IRS) allows taxpayers to make deductions on the interest paid on their mortgages.
But what if you get a second House mortgage? Doesn’t matter what you use it for? Can you deduct interest indefinitely?
We’ll take an in-depth look at the tax implications of obtaining a second mortgage, showing you how to calculate your tax deduction and highlighting various restrictions and pitfalls.
The basics
First, you need to understand what a “qualifying home” is (one to which a mortgage interest deduction applies) and how the IRS defines “mortgage interest” and “mortgage debt.”
First, “qualifying home” refers to your main home where you usually live, or your second home. Mobile homes, mobile homes, apartments and boats, as long as they have “sleeping, cooking and toilet facilities” qualify as IRS Publication 936 set.
If you own three or more properties, you can only claim two as, respectively, your primary and second home for a given year. If you sell one of the houses that you were claiming during that year, you can consider another property as your primary or second home for the remainder of that year.
If you are claiming deductions for a house that functions like something else, such as a rental property or an office, a number of innovative rules and calculations apply, related to the amount of time the premises occupy. You can check its details hereBut in general, if you rent a second home, you must live there for at least 14 days or more than 10% of the rented time for a year (whichever is longer) in order to pay the mortgage interest. (If you don’t live there at all, you own it and a different set of rules apply – see Tax deductions for rental property owners).
Mortgage interest only applies to interest paid on loans that use your home (s) as collateral. This includes:
- First mortgages and second mortgages
- Credit lines
- Home Equity Loans
The IRS describes three categories of mortgage debt. These vary depending on when you took out the debt and the income used:
- Old-fashioned hunting refers to mortgages secured by your home on or before October 13, 1987 (after which the current tax rules went into effect).
- Home purchase debt refers to mortgages obtained after October 13, 1987 that were used to purchase, build, or improve your home (ie, renovations, repairs, etc.).
- Debt or Home Equity Loan refers to mortgages taken out after October 13, 1987 that were used for other non-residency purposes, such as college tuition, a new car, a vacation, or many other things not related to the purchase, construction or improvement of the town.
Deductions
That depends on the type of debt you already have and how much more you need to accept. If you are married filing a joint return, you can only deduct interest on a debt of $ 1 million or less for home purchase debt and $ 100,000 or less on total home equity debt. If you are single or married filing separately, then the limits for home purchase debt and home equity debt are $ 500,000, respectively.
That is, if your mortgage or mortgages are used to buy, build, or improve your main and / or second home (and convert it to home purchase debt) for a total of $ 1 million, you can deduct the interest. For example, if you have a 4% interest rate on each of the two mortgages totaling $ 1 million, you can deduct all of your annual interest payments of $ 40,000.
However, if your home purchase debt is, say, $ 2 million, then you will only be able to deduct half of the total interest you paid on mortgages worth $ 2 million in that year. If the same 4% interest rates were applied, you could only deduct $ 40,000 instead of the $ 80,000 you probably paid in interest that year. (This is something for anyone looking to finance a seven-figure property. See Jumbo vs. Conventional mortgages: how they differ.)
While this limit does not apply to bisexual debt, you won’t be able to make additional deductions on new mortgages if your long-term debt already exceeds $ 1 million. What if you only have $ 900,000 in long-term debt? Then you could only deduct interest on an additional $ 100,000 on home purchase debt.
At least, this is the general rule. The IRS provides a spreadsheet to determine the actual deductible interest on the home mortgage.
Paper
As long as you have paid a mortgage value of at least $ 600, you will receive a notice from your mortgagee or lender (usually Form 1098) a few months before your tax filing date. Along with a dollar amount of your annual payments, this Mortgage Interest Statement will show your mortgage insurance premiums paid and deductible points paid (if you bought a home that year). Once you have this document handy, you will use it to complete your tax return, the Form 1040, Schedule A (Expected Deductions).
With home purchase debt and home equity debt combined, you can technically borrow $ 1.1 million against your home. However, if you have additional debt that exceeds this threshold, you may be able to deduct interest if this income was used at a qualified cost, such as an investment (also described in Schedule A) or in business. (Annex C. O C-EZ).
Refinancing, points and premiums
If you refinance one mortgage, including your second, you can claim the new loan as home purchase debt up to the principal on the old loan. Anything above that will be treated as home equity debt.
Also, if you pay points on the new mortgage, you can deduct them over the life of the loan. Assuming you refinance a new 30-year mortgage, you can deduct 1/30ú of what you paid in points each year. If you haven’t deducted all the points when you sell or refinance the home (again), you can deduct any remaining balance at the same time in that year. You will present the deduction on Schedule A, form 1040, line 12.
As long as your adjusted gross income does not exceed $ 109,000 (or $ 54,500 if you are married and file a separate return), you can also deduct some or all of your mortgage insurance premiums. This would fall under the category of ‘home purchase debt’.
The bottom line
The tax rules are complicated, that can’t be denied, but if you go ahead correctly, the provisions could save you thousands of dollars a year. Be sure to consult a qualified tax professional before deciding to take out a second mortgage.
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