TheTaxPages.com - Deductions

Interest Expense

Interest is an amount you pay for the use of borrowed money.

The types of interest you can deduct as itemized deductions are investment interest and home mortgage interest, including certain points.

You cannot deduct personal interest. Personal interest includes interest paid on a loan to purchase a car for personal use, credit card and installment interest incurred for personal expenses.

Items you cannot deduct as interest include points (if you are a seller), service charges, credit investigation fees, and interest relating to tax–exempt income, such as interest to purchase or carry tax–exempt securities.

Business Interest on rental or business property is not an itemized deduction. You claim this interest on either Schedule E or Schedule C.

Student Loan Interest is not an itemized deduction but can deduct up to $2,500 of student loan interest from your income on Form 1040 or Form 1040A.

HOME MORTGAGE INTEREST

Home mortgage interest is interest you pay on a loan secured by your main home or a second home. The loan may be a mortgage to buy your home, a second mortgage, a home equity loan, or a line of credit.

Your main home is where you live most of the time. It can be a house, cooperative apartment, condominium, mobile home, house trailer, or houseboat that has sleeping, cooking and toilet facilities.

A second home can include any other residence you own, and treat as a second home. You do not have to use the home during the year. However, if you rent it to others, you must also use it as a home during the year for more than the greater of 14 days or 10 percent of the number of days you rent it, for the interest to qualify as home mortgage interest.

Home mortgage interest and points are generally reported to you on Form 1098, Mortgage Interest Statement, by the financial institution to which you made the payments.

POINTS

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

You can deduct the points in full in the year they are paid, if all the following requirements are met:

Your loan is secured by your main home (The home you live in most of the time).
Paying points is an established business practice in your area.
The points paid were not more than the amount generally charged in that area.
You use the cash method of accounting.
The points were not paid for items that usually are separately stated on the settlement sheet such as appraisal fees, inspection fees, title fees, attorney fees, or property taxes.
You provided funds at or before closing, that were at least as much as the points charged, not counting points paid by the seller. You cannot have borrowed the funds from your lender or mortgage broker in order to pay the points.
You use your loan to buy or build your main home.
The points were computed as a percentage of the principal amount of the mortgage, and
The amount is clearly shown on your settlement statement.

Points that do not meet these requirements may be deductible over the life of the loan.

Refinancing. Points paid for refinancing generally can only be deducted over the life of the new mortgage. However, if you use part of the refinanced mortgage proceeds to improve your main home and you meet the first six requirements stated previously, you can fully deduct the part of the points related to the improvement in the year you paid them with your own funds.

Seller paid points cannot be deducted as interest on the seller's return, they are a selling expense which will reduce the amount of gain realized. Points paid by the seller may be deducted by the buyer provided the buyer subtracts the amount from the basis, or cost, of the residence.

Points you pay on loans secured by your second home, can be deducted only over the life of the loan.

INVESTMENT INTEREST

If you borrow money to buy property you hold for investment, the interest you pay is investment interest. You can deduct investment interest. However, you cannot deduct interest you incurred to produce tax-exempt income.

Investment interest does not include any qualified home mortgage interest or any interest taken into account in computing income or loss from a passive activity.

Investment property. Property held for investment includes property that produces interest, dividends, annuities, or royalties not derived in the ordinary course of a trade or business. Investment property also includes an interest in a trade or business activity in which you did not materially participate (other than a passive activity).

Generally, your deduction for investment interest expense is limited to the amount of your net investment income.

You can carry over the amount of investment interest that you could not deduct because of this limit to the next tax year.

For more information, refer to: