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Mortgage interest tax deductions for first time homebuyers

Iris Price | Improvement Center Columnist | March 18, 2016

stack of coinsDoes the thought of filing taxes fill you with dread? If you bought your first home last year, cheer up. As a first time homebuyer you're about to discover a major benefit of homeownership: mortgage interest tax deductions. By deducting from your taxable income the interest you paid on your home mortgage, you can substantially reduce how much tax you owe.

If you already file a 1040 and claim other deductions, you are probably familiar with how they can ease your tax burden, but mortgage interest can be the big daddy of them all. For those who have taken only the standard deduction, you may be amazed by comparison at what this deduction can save you.

Here are the nuts and bolts of mortgage interest tax deductions -- what other types of home-related loans are eligible, how much you can deduct, which homes qualify and what paperwork you need to file.

Which loans qualify for the mortgage interest tax deduction?

You may deduct all of the mortgage interest you pay on a secured debt that puts up your home as collateral -- in other words, one for which the lender can take ownership of your home to satisfy the loan if you ever default. Liens against your home for unpaid debts, judgments, and wraparound mortgages not recorded with the state do not qualify as loans secured by your home. Interest charged for personal loans or credit card debt, even if used toward the purchase of a home, is not deductible.

As a first time homebuyer, you may want to consider some future tax deductions, too. In addition to acquisition debt -- a mortgage to buy, build, or improve your main home and even a second home -- the following types of loans can also qualify:

  • A second mortgage.
  • A home equity line of credit (HELOC).
  • A home equity loan.

Refinancing your present mortgage, which may prove advantageous one day, also qualifies, up to the balance of the old mortgage. Anything additional you borrow beyond that balance on the re-fi loan is treated as home equity debt -- used for something other than building, buying, or improving your home -- and limited to no more than $100,000 ($50,000 if married and filing separately.)

Does your home qualify?

As a first time homebuyer, you might have only the mortgage for your main home, the one where you live all or most of the time. Mortgage interest for a second home can qualify, too, if you don't rent it out or offer it for resale.

If you don't rent it out, it can stand empty and still qualify. However, if you do rent it, the following stipulations apply:

  • You have to live there at least 14 days out of the year or the number of days equal to 10 percent of the amount of time renters live there, whichever is longer.
  • If you do not live there the required amount of time, it's considered rental property. The interest is not deductible.

You can have more than one second home during the year but not at the same time. You can buy another second home and switch the designations or switch your main home and a second home. Likewise, if you sell one of your homes, you can buy another second home or redesignate which is the main and which is the second home.

If you use a part of your home for business, you may have to deduct part of your mortgage interest as a business expense.

How much can you deduct?

Your mortgage interest is fully deductible if one or more of the following categories apply to your mortgage(s) for the entire year:

  • Grandfathered debt, a mortgage taken prior to or on October 13, 1987.
  • Balances of acquisition debt for all of last year up to $1,000,000 ($500,000 if married, filing separately) for mortgages taken after October 13, 1987.
  • Debt balances for all of last year of up to $100,000 ($50,000 if married, filing separately) for home equity debt totaling no more than fair market value of homes that secure the debts in the other two categories minus those debts.

Points, or loan origination fees as they are sometimes called, can be considered interest, but many conditions apply that affect whether they are deductible for the year in which you took out the mortgage. Often, they must be deducted in equal parts over the term of the mortgage.

What paperwork do you need to calculate your deduction?

In January your mortgage holder should have sent you Form 1098, a statement of any mortgage interest of more than $600 you paid last year. This amount appears in Box 1. If it includes prepaid interest accrued for January of the current year, you have to figure that amount and deduct it from the amount of mortgage interest paid last year that you report on last year's tax return. Whether or not any points you paid appear in Box 2, they may be deductible. Any mortgage interest refunds are shown in Box 3. Mortgage insurance premiums, also deductible, appear in Box 4.

You calculate your mortgage interest deductions on Schedule A. However, if you maintained a designated home office, you calculate part of your interest deductions on Schedule C. For rental property, use Schedule E.

For answers to more specific questions regarding your circumstances and your tax liability, refer to IRS Publication 936, Home Mortgage Interest Deduction or consult a qualified tax specialist.

About the Author

Iris Price is a single Baby Boomer whose antidote to a lack of retirement funds was to launch a long-delayed career as a writer. While others her age concoct bucket lists and travel the world, she bought a new-construction home and obsessively creates lists of must-have home improvements and personal realization goals. She specializes in writing about home services and self-motivation.