Matt, who is single, has always elected to itemize deductions rather than take t
ID: 2357565 • Letter: M
Question
Matt, who is single, has always elected to itemize deductions rather than take the standard deduction. In prior years, his itemized deductions always exceeded the standard deduction by a substantial amount. As a result of paying off the mortgage on his residence, he projects that his itemized deductions for 2012 will exceed the standard deduction by only $500. Matt anticipates that the amount of his itemized deductions will remain about the same in the foreseeable future. Matt's AGI is $150,000. He is investing the amount of his former mortgage payment each month in tax-exempt bonds that were issued five years ago. A friend recommends that Matt buy a beach house to increase his itemized deductions with the mortgage interest deduction. What are the relevant tax issues for Mike?Explanation / Answer
Part I. Home Mortgage Interest
This part explains what you can deduct as home mortgage interest. It includes discussions on points, mortgage insurance premiums, and how to report deductible interest on your tax return.
Generally, home mortgage interest is any interest you pay on a loan secured by your home (main home or a second home). The loan may be a mortgage to buy your home, a second mortgage, a line of credit, or a home equity loan.
You can deduct home mortgage interest if all the following conditions are met.
You file Form 1040 and itemize deductions on Schedule A (Form 1040).
The mortgage is a secured debt on a qualified home in which you have an ownership interest. Secured Debt and Qualified Homeare explained later.
Both you and the lender must intend that the loan be repaid.
Fully deductible interest. In most cases, you can deduct all of your home mortgage interest. How much you can deduct depends on the date of the mortgage, the amount of the mortgage, and how you use the mortgage proceeds.
If all of your mortgages fit into one or more of the following three categories at all times during the year, you can deduct all of the interest on those mortgages. (If any one mortgage fits into more than one category, add the debt that fits in each category to your other debt in the same category.) If one or more of your mortgages does not fit into any of these categories, use Part II of this publication to figure the amount of interest you can deduct.
The three categories are as follows.
Mortgages you took out on or before October 13, 1987 (called grandfathered debt).
Mortgages you took out after October 13, 1987, to buy, build, or improve your home (called home acquisition debt), but only if throughout 2015 these mortgages plus any grandfathered debt totaled $1 million or less ($500,000 or less if married filing separately).
Mortgages you took out after October 13, 1987, other than to buy, build, or improve your home (called home equity debt), but only if throughout 2015 these mortgages totaled $100,000 or less ($50,000 or less if married filing separately) and totaled no more than the fair market value of your home reduced by (1) and (2).
The dollar limits for the second and third categories apply to the combined mortgages on your main home and second home.
See Part II for more detailed definitions of grandfathered, home acquisition, and home equity debt.
You can use Figure A to check whether your home mortgage interest is fully deductible.
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Figure A. Is My Home Mortgage Interest Fully Deductible?
Secured Debt
You can deduct your home mortgage interest only if your mortgage is a secured debt. A secured debt is one in which you sign an instrument (such as a mortgage, deed of trust, or land contract) that:
Makes your ownership in a qualified home security for payment of the debt,
Provides, in case of default, that your home could satisfy the debt, and
Is recorded or is otherwise perfected under any state or local law that applies.
In other words, your mortgage is a secured debt if you put your home up as collateral to protect the interests of the lender. If you cannot pay the debt, your home can then serve as payment to the lender to satisfy (pay) the debt. In this publication, mortgage will refer to secured debt.
Debt not secured by home. A debt is not secured by your home if it is secured solely because of a lien on your general assets or if it is a security interest that attaches to the property without your consent (such as a mechanic's lien or judgment lien).
A debt is not secured by your home if it once was, but is no longer secured by your home.
Wraparound mortgage. This is not a secured debt unless it is recorded or otherwise perfected under state law.
Example.
Beth owns a home subject to a mortgage of $40,000. She sells the home for $100,000 to John, who takes it subject to the $40,000 mortgage. Beth continues to make the payments on the $40,000 note. John pays $10,000 down and gives Beth a $90,000 note secured by a wraparound mortgage on the home. Beth does not record or otherwise perfect the $90,000 mortgage under the state law that applies. Therefore, the mortgage is not a secured debt and John cannot deduct any of the interest he pays on it as home mortgage interest.
Choice to treat the debt as not secured by your home. You can choose to treat any debt secured by your qualified home as not secured by the home. This treatment begins with the tax year for which you make the choice and continues for all later tax years. You can revoke your choice only with the consent of the Internal Revenue Service (IRS).
You may want to treat a debt as not secured by your home if the interest on that debt is fully deductible (for example, as a business expense) whether or not it qualifies as home mortgage interest. This may allow you, if the limits in Part II apply, more of a deduction for interest on other debts that are deductible only as home mortgage interest.
Cooperative apartment owner. If you own stock in a cooperative housing corporation, see the Special Rule for Tenant-Stockholders in Cooperative Housing Corporations , near the end of this Part I.
Qualified Home
For you to take a home mortgage interest deduction, your debt must be secured by a 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.
The interest you pay on a mortgage on a home other than your main or second home may be deductible if the proceeds of the loan were used for business, investment, or other deductible purposes. Otherwise, it is considered personal interest and is not deductible.
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. A second home is a home that you choose to treat as your second home.
Second home not rented out. If you have a second home that you do not hold out for rent or resale to others at any time during the year, you can treat it as a qualified home. You do not have to use the home during the year.
Second home rented out. If you have a second home and rent it out part of the year, you also must use it as a home during the year for it to be a qualified home. You must use this home more than 14 days or more than 10% of the number of days during the year that the home is rented at a fair rental, whichever is longer. If you do not use the home long enough, it is considered rental property and not a second home. For information on residential rental property, see Pub. 527.
More than one second home. If you have more than one second home, you can treat only one as the qualified second home during any year. However, you can change the home you treat as a second home during the year in the following situations.
If you get a new home during the year, you can choose to treat the new home as your second home as of the day you buy it.
If your main home no longer qualifies as your main home, you can choose to treat it as your second home as of the day you stop using it as your main home.
If your second home is sold during the year or becomes your main home, you can choose a new second home as of the day you sell the old one or begin using it as your main home.
Divided use of your home. The only part of your home that is considered a qualified home is the part you use for residential living. If you use part of your home for other than residential living, such as a home office, you must allocate the use of your home. You must then divide both the cost and fair market value of your home between the part that is a qualified home and the part that is not. Dividing the cost may affect the amount of your home acquisition debt, which is limited to the cost of your home plus the cost of any improvements. (See Home Acquisition Debt in Part II.) Dividing the fair market value may affect your home equity debt limit, also explained in Part II .
Renting out part of home. If you rent out part of a qualified home to another person (tenant), you can treat the rented part as being used by you for residential living only if all of the following conditions apply.
The rented part of your home is used by the tenant primarily for residential living.
The rented part of your home is not a self-contained residential unit having separate sleeping, cooking, and toilet facilities.
You do not rent (directly or by sublease) the same or different parts of your home to more than two tenants at any time during the tax year. If two persons (and dependents of either) share the same sleeping quarters, they are treated as one tenant.
Office in home. If you have an office in your home that you use in your business, see Pub. 587, Business Use of Your Home. It explains how to figure your deduction for the business use of your home, which includes the business part of your home mortgage interest.
Home under construction. You can treat a home under construction as a qualified home for a period of up to 24 months, but only if it becomes your qualified home at the time it is ready for occupancy.
The 24-month period can start any time on or after the day construction begins.
Home destroyed. You may be able to continue treating your home as a qualified home even after it is destroyed in a fire, storm, tornado, earthquake, or other casualty. This means you can continue to deduct the interest you pay on your home mortgage, subject to the limits described in this publication.
You can continue treating a destroyed home as a qualified home if, within a reasonable period of time after the home is destroyed, you:
Rebuild the destroyed home and move into it, or
Sell the land on which the home was located.
This rule applies to your main home and to a second home that you treat as a qualified home.
Time-sharing arrangements. You can treat a home you own under a time-sharing plan as a qualified home if it meets all the requirements. A time-sharing plan is an arrangement between two or more people that limits each person's interest in the home or right to use it to a certain part of the year.
Rental of time-share. If you rent out your time-share, it qualifies as a second home only if you also use it as a home during the year. SeeSecond home rented out , earlier, for the use requirement. To know whether you meet that requirement, count your days of use and rental of the home only during the time you have a right to use it or to receive any benefits from the rental of it.
Married taxpayers. If you are married and file a joint return, your qualified home(s) can be owned either jointly or by only one spouse.
Separate returns. If you are married filing separately and you and your spouse own more than one home, you can each take into account only one home as a qualified home. However, if you both consent in writing, then one spouse can take both the main home and a second home into account