Deductible Mortgage Interest

To be deductible, the interest you pay must be on a loan secured by your main home or a second home. The loan can be a first or second mortgage, a home improvement loan, or a home equity loan.

Prepaid interest.   If you pay interest in advance for a period that goes beyond the end of the tax year, you must spread this interest over the tax years to which it applies. Generally, you can deduct in each year only the interest that qualifies as home mortgage interest for that year. An exception applies to points, which are discussed later.

Late payment charge on mortgage payment.   You can deduct as home mortgage interest a late payment charge if it was not for a specific service in connection with your mortgage loan.

Mortgage prepayment penalty.   If you pay off your home mortgage early, you may have to pay a penalty. You can deduct that penalty as home mortgage interest provided the penalty is not for a specific service performed or cost incurred in connection with your mortgage loan.

Ground rent.   In some states (such as Maryland), you may buy your home subject to a ground rent. A ground rent is an obligation you assume to pay a fixed amount per year on the property. Under this arrangement, you are leasing (rather than buying) the land on which your home is located.

Redeemable ground rents.   If you make annual or periodic rental payments on a redeemable ground rent, you can deduct the payments as mortgage interest. The ground rent is a redeemable ground rent only if all of the following are true.

• Your lease, including renewal periods, is for more than 15 years.


• You can freely assign the lease.


• You have a present or future right (under state or local law) to end the lease and buy the lessor’s entire interest in the land by paying a specified amount.


• The lessor’s interest in the land is primarily a security interest to protect the rental payments to which he or she is entitled.

  Payments made to end the lease and buy the lessor’s entire interest in the land are not redeemable ground rents. You cannot deduct them.

Nonredeemable ground rents.   Payments on a nonredeemable ground rent are not mortgage interest. You can deduct them as rent only if they are a business expense or if they are for rental property.

Cooperative apartment.   You can usually treat the interest on a loan you took out to buy stock in a cooperative housing corporation as home mortgage interest if you own a cooperative apartment and the cooperative housing corporation meets the conditions described earlier under Special Rules for Cooperatives. In addition, you can treat as home mortgage interest your share of the corporation’s deductible mortgage interest. Figure your share of mortgage interest the same way that is shown for figuring your share of real estate taxes in the Example under Division of real estate taxes, earlier. For more information on cooperatives, see Special Rule for Tenant-Stockholders in Cooperative Housing Corporations in Publication 936.

Refund of cooperative’s mortgage interest.   You must reduce your mortgage interest deduction by your share of any cash portion of a patronage dividend that the cooperative receives. The patronage dividend is a partial refund to the cooperative housing corporation of mortgage interest it paid in a prior year.

  If you receive a Form 1098 from the cooperative housing corporation, the form should show only the amount you can deduct.

Figure A. Are my points fully deductible this year?

Mortgage Interest Paid at Settlement

One item that normally appears on a settlement or closing statement is home mortgage interest.

You can deduct the interest that you pay at settlement if you itemize your deductions on Schedule A (Form 1040). This amount should be included in the mortgage interest statement provided by your lender. See the discussion under Mortgage Interest Statement, later. Also, if you pay interest in advance, see Prepaid interest, earlier, and Points, next.

Points

The term “points” is used to describe certain charges paid, or treated as paid, by a borrower to obtain a home mortgage. Points also may be called loan origination fees, maximum loan charges, loan discount, or discount points.

A borrower is treated as paying any points that a home seller pays for the borrower’s mortgage. See Points paid by the seller, later.

General rule.   You cannot deduct the full amount of points in the year paid. They are prepaid interest, so you generally must deduct them over the life (term) of the mortgage.

Exception.   You can deduct the full amount of points in the year paid if you meet all the following tests.

1. Your loan is secured by your main home. (Generally, your main home is the one you live in most of the time.)


2. Paying points is an established business practice in the area where the loan was made.


3. The points paid were not more than the points generally charged in that area.


4. You use the cash method of accounting. This means you report income in the year you receive it and deduct expenses in the year you pay them. Most individuals use this method.


5. The points were not paid in place of amounts that ordinarily are stated separately on the settlement statement, such as appraisal fees, inspection fees, title fees, attorney fees, and property taxes.


6. The funds you provided at or before closing, plus any points the seller paid, were at least as much as the points charged. The funds you provided do not have to have been applied to the points. They can include a down payment, an escrow deposit, earnest money, and other funds you paid at or before closing for any purpose. You cannot have borrowed these funds from your lender or mortgage broker.


7. You use your loan to buy or build your main home.


8. The points were computed as a percentage of the principal amount of the mortgage.


9. The amount is clearly shown on the settlement statement (such as the Uniform Settlement Statement, Form HUD-1) as points charged for the mortgage. The points may be shown as paid from either your funds or the seller’s.

Note.

If you meet all of the tests listed above and you itemize your deductions in the year you get the loan, you can either deduct the full amount of points in the year paid or deduct them over the life of the loan, beginning in the year you get the loan. If you do not itemize your deductions in the year you get the loan, you can spread the points over the life of the loan and deduct the appropriate amount in each future year, if any, when you do itemize your deductions.

Home improvement loan.   You can also fully deduct in the year paid points paid on a loan to improve your main home, if you meet the first six tests listed earlier.

Refinanced loan.   If you use part of the refinanced mortgage proceeds to improve your main home and you meet the first six tests listed earlier, you can fully deduct the part of the points related to the improvement in the year you paid them with your own funds. You can deduct the rest of the points over the life of the loan.

Points not fully deductible in year paid.    If you do not qualify under the exception to deduct the full amount of points in the year paid (or choose not to do so), see Points in Publication 936, Home Mortgage Interest Deduction, for the rules on when and how much you can deduct.

Figure A.   You can use Figure A as a quick guide to see whether your points are fully deductible in the year paid.

Amounts charged for services.   Amounts charged by the lender for specific services connected to the loan are not interest. Examples of these charges are:

• Appraisal fees,


• Notary fees, and


• Preparation costs for the mortgage note or deed of trust.

You cannot deduct these amounts as points either in the year paid or over the life of the mortgage. For information about the tax treatment of these amounts and other settlement fees. and closing costs, see Basis, later.

Points paid by the seller.   The term “points” includes loan placement fees that the seller pays to the lender to arrange financing for the buyer.

Treatment by seller.   The seller cannot deduct these fees as interest; but, they are a selling expense that reduces the seller’s amount realized. See Publication 523 for more information.

Treatment by buyer.   The buyer treats seller-paid points as if he or she had paid them. If all the tests listed earlier under Exception are met, the buyer can deduct the points in the year paid. If any of those tests are not met, the buyer must deduct the points over the life of the loan.

  The buyer must also reduce the basis of the home by the amount of the seller-paid points. For more information about the basis of your home, see Basis, later.

Funds provided are less than points.   If you meet all the tests listed earlier under Exception except that the funds you provided were less than the points charged to you (test 6), you can deduct the points in the year paid up to the amount of funds you provided. In addition, you can deduct any points paid by the seller.

Example 1.

When you took out a $100,000 mortgage loan to buy your home in December, you were charged one point ($1,000). You meet all the tests for deducting points in the year paid (see Exception, earlier), except the only funds you provided were a $750 down payment. Of the $1,000 you were charged for points, you can deduct $750 in the year paid. You spread the remaining $250 over the life of the mortgage.

Example 2.

The facts are the same as in Example 1, except that the person who sold you your home also paid one point ($1,000) to help you get your mortgage. In the year paid, you can deduct $1,750 ($750 of the amount you were charged plus the $1,000 paid by the seller). You spread the remaining $250 over the life of the mortgage. You must reduce the basis of your home by the $1,000 paid by the seller.

Excess points.   If you meet all the tests under Exception except that the points paid were more than are generally charged in your area (test 3), you can deduct in the year paid only the points that are generally charged. You must spread any additional points over the life of the mortgage.

Mortgage ending early.   If you spread your deduction for points over the life of the mortgage, you can deduct any remaining balance in the year the mortgage ends. A mortgage may end early due to a prepayment, refinancing, foreclosure, or similar event.

Example.

Dan paid $3,000 in points in 2000 that he had to spread out over the 15-year life of the mortgage. He had deducted $1,400 of these points through 2006.

Dan prepaid his mortgage in full in 2007. He can deduct the remaining $1,600 of points in 2007.

Exception.   If you refinance the mortgage with the same lender, you cannot deduct any remaining points for the year. Instead, deduct them over the term of the new loan.

Form 1098.   The mortgage interest statement you receive should show not only the total interest paid during the year, but also your deductible points paid during the year. See Mortgage Interest Statement, later.

Where To Deduct Home Mortgage Interest

Enter on Schedule A (Form 1040), line 10, the home mortgage interest and points reported to you on Form 1098 (discussed next). If you did not receive a Form 1098, enter your deductible interest on line 11, and any deductible points on line 12. See Table 1 for a summary of where to deduct home mortgage interest and real estate taxes.

If you paid home mortgage interest to the person from whom you bought your home, show that person’s name, address, and social security number (SSN) or employer identification number (EIN) on the dotted lines next to line 11. The seller must give you this number and you must give the seller your SSN. Form W-9, Request for Taxpayer Identification Number and Certification, can be used for this purpose. Failure to meet either of these requirements may result in a $50 penalty for each failure.

Mortgage Interest Statement

If you paid $600 or more of mortgage interest (including certain points and mortgage insurance premiums) during the year on any one mortgage to a mortgage holder in the course of that holder’s trade or business, you should receive a Form 1098 or similar statement from the mortgage holder. The statement will show the total interest paid on your mortgage during the year. If you bought a main home during the year, it also will show the deductible points you paid and any points you can deduct that were paid by the person who sold you your home. See Points, earlier.

The interest you paid at settlement should be included on the statement. If it is not, add the interest from the settlement sheet that qualifies as home mortgage interest to the total shown on Form 1098 or similar statement. Put the total on Schedule A (Form 1040), line 10, and attach a statement to your return explaining the difference. Write “See attached” to the right of line 10.

A mortgage holder can be a financial institution, a governmental unit, or a cooperative housing corporation. If a statement comes from a cooperative housing corporation, it generally will show your share of interest.

Your mortgage interest statement for 2007 should be provided or sent to you by January 31, 2008. If it is mailed, you should allow adequate time to receive it before contacting the mortgage holder. A copy of this form will be sent to the IRS also.

Example.

You bought a new home on May 3. You paid no points on the purchase. During the year, you made mortgage payments which included $4,480 deductible interest on your new home. The settlement sheet for the purchase of the home included interest of $620 for 29 days in May. The mortgage statement you receive from the lender includes total interest of $5,100 ($4,480 + $620). You can deduct the $5,100 if you itemize your deductions.

Refund of overpaid interest.   If you receive a refund of mortgage interest you overpaid in a prior year, you generally will receive a Form 1098 showing the refund in box 3. Generally, you must include the refund in income in the year you receive it. See Refund of home mortgage interest, earlier, under Home Mortgage Interest.

More than one borrower.   If you and at least one other person (other than your spouse if you file a joint return) were liable for and paid interest on a mortgage that was for your home, and the other person received a Form 1098 showing the interest that was paid during the year, attach a statement to your return explaining this. Show how much of the interest each of you paid, and give the name and address of the person who received the form. Deduct your share of the interest on Schedule A (Form 1040), line 11, and write “See attached” to the right of that line.

Mortgage Insurance Premiums

You can take an itemized deduction on line 13, Schedule A (Form 1040), for premiums you pay or accrue during 2007 for qualified mortgage insurance in connection with home acquisition debt on your qualified home.

Mortgage insurance premiums you paid or accrued on any mortgage insurance contract issued before January 1, 2007, are not deductible as an itemized deduction. Mortgage insurance premiums you paid or accrued after December 31, 2007, or that are properly allocable to any period after December 31, 2007, are not deductible as an itemized deduction.

Qualified Mortgage Insurance

Qualified mortgage insurance is mortgage insurance provided by the Veterans Administration, the Federal Housing Administration, or the Rural Housing Administration, and private mortgage insurance (as defined in section 2 of the Homeowners Protection Act of 1998 as in effect on December 20, 2006).

Special rules for prepaid mortgage insurance.   If you paid premiums for qualified mortgage insurance that are properly allocable to periods after the close of the taxable year, such premiums are treated as paid in the period to which they are allocated. No deduction is allowed for the unamortized balance if the mortgage is satisfied before its term. The two preceding sentences do not apply to qualified mortgage insurance provided by the Department of Veterans Affairs or Rural Housing Service.

Home Acquisition Debt

Home acquisition debt is a mortgage you took out after October 13, 1987, to buy, build, or substantially improve a qualified home. It also must be secured by that home.

If the amount of your mortgage is more than the cost of the home plus the cost of any substantial improvements, only the debt that is not more than the cost of the home plus improvements qualifies as home acquisition debt.

Home acquisition debt limit.   The total amount you can treat as home acquisition debt at any time on your home cannot be more than $1 million ($500,000 if married filing separately).

Qualified Home

This means your main home or your second home. A home includes a house, condominium, cooperative, mobile home, house trailer, boat, or similar property that has sleeping, cooking, and toilet facilities.

Main home.   You can have only one main home at any one time. This is the home where you ordinarily live most of the time.

Second home and other special situations.   If you have a second home, use part of your home for other than residential living (such as a home office), rent out part of your home, or are having your home constructed, see Qualified Home in Publication 936.

Limit on Deduction

If your adjusted gross income (AGI) on Form 1040, line 38, is more than $100,000 ($50,000 if your filing status is married filing separately), the amount of your mortgage insurance premiums that are deductible is reduced and may be eliminated. See Line 13 in the instructions for Schedule A&B (Form 1040) and complete the Mortgage Insurance Premiums Deduction Worksheet to figure the amount you can deduct. If your AGI is more than $109,000 ($54,500 if married filing separately), you cannot deduct your mortgage insurance premiums.

Form 1098.   The amount of mortgage insurance premiums you paid during 2007, should be reported in box 4; see Form 1098, Mortgage Interest Statement in Publication 936.

Mortgage Interest Credit

The mortgage interest credit is intended to help lower-income individuals afford home ownership. If you qualify, you can claim the credit each year for part of the home mortgage interest you pay.

Who qualifies.   You may be eligible for the credit if you were issued a mortgage credit certificate (MCC) from your state or local government. Generally, an MCC is issued only in connection with a new mortgage for the purchase of your main home.

The MCC will show the certificate credit rate you will use to figure your credit. It also will show the certified indebtedness amount. Only the interest on that amount qualifies for the credit. See Figuring the Credit, later.

Table 1. Where To Deduct Interest and Taxes Paid on Your Home

See the text for information on what expenses are eligible.

You must contact the appropriate government agency about getting an MCC before you get a mortgage and buy your home. Contact your state or local housing finance agency for information about the availability of MCCs in your area.

How to claim the credit.   To claim the credit, complete Form 8396 and attach it to your Form 1040. Include the credit in your total for Form 1040, line 54; be sure to check box a on that line.

Reducing your home mortgage interest deduction.   If you itemize your deductions on Schedule A (Form 1040), you must reduce your home mortgage interest deduction by the amount of the mortgage interest credit shown on Form 8396, line 3. You must do this even if part of that amount is to be carried forward to 2008.

Selling your home.   If you purchase a home after 1990 using an MCC, and you sell that home within 9 years, you may have to recapture (repay) all or part of the benefit you received from the MCC program. For additional information, see Recapturing (Paying Back) a Federal Mortgage Subsidy, in Publication 523.

Figuring the Credit

Figure your credit on Form 8396.

Mortgage not more than certified indebtedness.   If your mortgage loan amount is equal to (or smaller than) the certified indebtedness amount shown on your MCC, enter on Form 8396, line 1, all the interest you paid on your mortgage during the year.

Mortgage more than certified indebtedness.   If your mortgage loan amount is larger than the certified indebtedness amount shown on your MCC, you can figure the credit on only part of the interest you paid. To find the amount to enter on line 1, multiply the total interest you paid during the year on your mortgage by the following fraction.

	Certified indebtedness amount on your MCC
	Original amount of your mortgage

  The fraction will not change as long as you are entitled to take the mortgage interest credit.

Example.

Emily bought a home this year. Her mortgage loan is $125,000. The certified indebtedness amount on her MCC is $100,000. She paid $7,500 interest this year. Emily figures the interest to enter on Form 8396, line 1, as follows:

	$100,000 $125,000	=	80%	(.80)
	$7,500	x	.80	=	$6,000

Emily enters $6,000 on Form 8396, line 1. In each later year, she will figure her credit using only 80% of the interest she pays for that year.

Limits

Two limits may apply to your credit.

• A limit based on the credit rate, and


• A limit based on your tax.

Limit based on credit rate.   If the certificate credit rate is higher than 20%, the credit you are allowed cannot be more than $2,000.

Limit based on tax.   Your credit (after applying the limit based on the credit rate) generally cannot be more than your regular tax liability on Form 1040, line 44, plus any alternative minimum tax on Form 1040, line 45, minus certain other credits. Use Form 8396 to figure this limit.

Dividing the Credit

If two or more persons (other than a married couple filing a joint return) hold an interest in the home to which the MCC relates, the credit must be divided based on the interest held by each person.

Example.

John and his brother, George, were issued an MCC. They used it to get a mortgage on their main home. John has a 60% ownership interest in the home, and George has a 40% ownership interest in the home. John paid $5,400 mortgage interest this year and George paid $3,600.

The MCC shows a credit rate of 25% and a certified indebtedness amount of $130,000. The loan amount (mortgage) on their home is $120,000. The credit is limited to $2,000 because the credit rate is more than 20%.

John figures the credit by multiplying the mortgage interest he paid this year ($5,400) by the certificate credit rate (25%) for a total of $1,350. His credit is limited to $1,200 ($2,000 × 60%).

George figures the credit by multiplying the mortgage interest he paid this year ($3,600) by the certificate credit rate (25%) for a total of $900. His credit is limited to $800 ($2,000 × 40%).

Table 2. Effect of Refinancing on Your Credit

IF you get a new (reissued) MCC and the amount of your new mortgage is ...	THEN the interest you claim on Form 8396, line 1, is* ...
smaller than or equal to the certified indebtedness amount on the new MCC	all the interest paid during the year on your new mortgage.
larger than the certified indebtedness amount on the new MCC	interest paid during the year on your new mortgage multiplied by the following fraction.
		certified indebtedness amount on your new MCC
		original amount of your mortgage

*The credit using the new MCC cannot be more than the credit using the old MCC. See New MCC cannot increase your credit.

Carryforward

If your allowable credit is reduced because of the limit based on your tax, you can carry forward the unused portion of the credit to the next 3 years or until used, whichever comes first.

Example.

You receive a mortgage credit certificate from State X. This year, your regular tax liability is $1,100, you owe no alternative minimum tax, and your mortgage interest credit is $1,700. You claim no other credits. Your unused mortgage interest credit for this year is $600 ($1,700 - $1,100). You can carry forward this amount to the next 3 years or until used, whichever comes first.

Credit rate more than 20%.   If you are subject to the $2,000 limit because your certificate credit rate is more than 20%, you cannot carry forward any amount more than $2,000 (or your share of the $2,000 if you must divide the credit).

Example.

In the earlier example under Dividing the Credit, John and George used the entire $2,000 credit. The excess $150 for John ($1,350 - $1,200) and $100 for George ($900 - $800) cannot be carried forward to future years, despite the respective tax liabilities for John and George.

Refinancing

If you refinance your original mortgage loan on which you had been given an MCC, you must get a new MCC to be able to claim the credit on the new loan. The amount of credit you can claim on the new loan may change. Table 2 summarizes how to figure your credit if you refinance your original mortgage loan.

An issuer may reissue an MCC after you refinance your mortgage. If you did not get a new MCC, you may want to contact the state or local housing finance agency that issued your original MCC for information about whether you can get a reissued MCC.

Year of refinancing.   In the year of refinancing, add the applicable amount of interest paid on the old mortgage and the applicable amount of interest paid on the new mortgage, and enter the total on Form 8396, line 1.

  If your new MCC has a credit rate different from the rate on the old MCC, you must attach a statement to Form 8396. The statement must show the calculation for lines 1, 2, and 3 for the part of the year when the old MCC was in effect. It must show a separate calculation for the part of the year when the new MCC was in effect. Combine the amounts from both calculations for line 3, enter the total on line 3 of the form, and write “See attached” on the dotted line.

New MCC cannot increase your credit.   The credit that you claim with your new MCC cannot be more than the credit that you could have claimed with your old MCC.

  In most cases, the agency that issues your new MCC will make sure that it does not increase your credit. However, if either your old loan or your new loan has a variable (adjustable) interest rate, you will need to check this yourself. In that case, you will need to know the amount of the credit you could have claimed using the old MCC.

  There are two methods for figuring the credit you could have claimed. Under one method, you figure the actual credit that would have been allowed. This means you use the credit rate on the old MCC and the interest you would have paid on the old loan.

  If your old loan was a variable rate mortgage, you can use another method to determine the credit that you could have claimed. Under this method, you figure the credit using a payment schedule of a hypothetical self-amortizing mortgage with level payments projected to the final maturity date of the old mortgage. The interest rate of the hypothetical mortgage is the annual percentage rate (APR) of the new mortgage for purposes of the Federal Truth in Lending Act. The principal of the hypothetical mortgage is the remaining outstanding balance of the certified mortgage indebtedness shown on the old MCC.

You must choose one method and use it consistently beginning with the first tax year for which you claim the credit based on the new MCC.

As part of your tax records, you should keep your old MCC and the schedule of payments for your old mortgage.

District of Columbia First-Time Homebuyer Credit

You may be able to claim a one-time tax credit of up to $5,000 ($2,500 if married filing separately) if you buy a main home in the District of Columbia. You must reduce the basis of your home by the amount of the tentative credit.

The credit is not allowed if you acquired your home from certain related persons or by gift or inheritance.

You qualify for the credit if you (and your spouse if you are married) did not have an ownership interest in a main home in the District of Columbia for at least 1 year before buying the new home. Individuals with modified adjusted gross income of $90,000 or more ($130,000 or more in the case of a joint return) cannot claim the credit. Individuals with modified adjusted gross income between $70,000 and $90,000 (between $110,000 and $130,000 in the case of a joint return) can claim only a reduced credit.

Use Form 8859, District of Columbia First-Time Homebuyer Credit, to figure your credit. See the form and its instructions for more information.

Basis

Basis is your starting point for figuring a gain or loss if you later sell your home, or for figuring depreciation if you later use part of your home for business purposes or for rent.

While you own your home, you may add certain items to your basis. You may subtract certain other items from your basis. These items are called adjustments to basis and are explained later under Adjusted Basis.

It is important that you understand these terms when you first acquire your home because you must keep track of your basis and adjusted basis during the period you own your home. You also must keep records of the events that affect basis or adjusted basis. See Keeping Records, later.

Figuring Your Basis

How you figure your basis depends on how you acquire your home. If you buy or build your home, your cost is your basis. If you receive your home as a gift, your basis is usually the same as the adjusted basis of the person who gave you the property. If you inherit your home from a decedent, the fair market value at the date of the decedent’s death is generally your basis. Each of these topics is discussed later.

Fair market value.   This is the price at which property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and who both have a reasonable knowledge of all the necessary facts.

Property transferred from a spouse.   If your home is transferred to you from your spouse, or from your former spouse as a result of a divorce, your basis is the same as your spouse’s (or former spouse’s) adjusted basis just before the transfer. Publication 504, Divorced or Separated Individuals, fully discusses transfers between spouses.

Cost as Basis

The cost of your home, whether you purchased it or constructed it, is the amount you paid for it, including any debt you assumed.