Key tax shelter remains intact
Congress keeps threatening to chip away at the deduction for mortgage interest. In some instances, even an outright repeal has been advocated. However, at least for the time being, the basic rules for deductible mortgage interest—known formally as “qualified personal residence interest”—are still in place.
Background: There are two basic types of mortgage interest that may be deducted on your tax return. Each one has a limit.
1. Acquisition debts: You may fully deduct the mortgage interest paid on loan proceeds used to buy, build or substantially renovate a home if the loans are secured by either your principal residence or one other home (e.g., a vacation home). But the total principal amount of the acquisition debts cannot exceed $1 million.
2. Home equity debts: When permitted by state law, you also may fully deduct the interest on home equity loans secured by a qualified residence. The total amount of these loans is limited to $100,000. Also, the amount cannot exceed your equity in the residence (the home’s value minus other loans). With a home equity loan, you can use the loan proceeds any way you see fit.
Any mortgage debt existing prior to October 14, 1987, known as “grandfathered debt,” is treated as acquisition debt, regardless of the amount. The mortgage interest on post-October 13, 1987, acquisition debt is deductible on debts up to $1 million; the interest on home equity debt on debts up to $100,000.
Note that special rules apply to “points” paid to obtain a mortgage. (A point is equal to 1% of the borrowed amount.) The points may be currently deductible as mortgage interest if they were paid to purchase, build or improve a qualified home, but points on a refinancing must be deducted over the life of the loan. For instance, if you refinance your $150,000 mortgage with a 15-year loan this year and pay two points, or $3,000, to obtain a more favorable rate, you can deduct $200 in points annually ($3,000 divided by 15).
Furthermore, be aware that the “Pease rule” may reduce certain itemized deductions, including the deduction for mortgage interest, claimed by high-income taxpayers. The reduction is equal to 3% of the excess adjusted gross income (AGI) over a specified dollar threshold (but not by more than 80% overall). The AGI threshold for the Pease rule in 2014 is $254,200 for single filers and $305,050 for joint filers.
Final words: Do not take anything for granted. Check with your tax advisers to ensure that you are maximizing all the tax benefits of home ownership.