Chapter 24 Interest expense ey.com/EYTaxGuide
Mortgage Insurance Premiums. The deduction for qualified mortgage insurance as home mortgage interest expired and is not available for 2014.
This chapter discusses what interest expenses you can deduct. Interest is the amount you pay for the use of borrowed money.
The following are types of interest you can deduct as itemized deductions on Schedule A (Form 1040).
Home mortgage interest, including certain points and mortgage insurance premiums. Investment interest. This chapter explains these deductions. It also explains where to deduct other types of interest and lists some types of interest you cannot deduct.
Use Table 24-1
Table 24-1
IF you have . . . THEN deduct it on . . . AND for more information go to . . . deductible student loan interest Form 1040, line 33, or Form 1040A, line 18 Publication 970. deductible home mortgage interest and points reported on Form 1098 Schedule A (Form 1040), line 10 Publication 936. deductible home mortgage interest not reported on Form 1098 Schedule A (Form 1040), line 11 Publication 936. deductible points not reported on Form 1098 Schedule A (Form 1040), line 12 Publication 936. Text intentionally omitted. Text intentionally omitted. Text intentionally omitted. deductible investment interest (other than incurred to produce rents or royalties) Schedule A (Form 1040), line 14 Publication 550. deductible business interest (non-farm) Schedule C or C-EZ (Form 1040) Publication 535. deductible farm business interest Schedule F (Form 1040) Publications 225 and 535. deductible interest incurred to produce rents or royalties Schedule E (Form 1040) Publications 527 and 535. personal interest not deductible.
You may want to see:
936 Home Mortgage Interest Deduction550 Investment Income and Expenses 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. (Generally, your mortgage is a secured debt if you put your home up as collateral to protect the interest of the lender. The term “qualified home” means your main home or second home. For details, see Publication 936.) Both you and the lender must intend that the loan be repaid.
To be fully deductible as home mortgage interest, the interest must be on a debt that is secured by property that is a qualified residence. A qualified residence is property that is owned by you and used as a principal or second residence. A residence may, among other things, be a house, a cooperative apartment, a condominium, a house trailer, or a houseboat. To be considered a qualified residence, a houseboat must include basic living accommodations, including sleeping space, a toilet, and cooking facilities.
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.
Fully deductible interest. 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.)
The three categories are as follows:
Mortgages you took out on or before October 13, 1987 (called grandfathered debt).
All mortgage indebtedness existing on October 13, 1987 (grandfathered debt), is treated as acquisition indebtedness, regardless of the amount. The interest on this indebtedness is fully deductible.
Individuals who refinanced and increased their mortgage indebtedness before October 14, 1987, may have greater interest deductions than those individuals who waited until later, because new or refinanced indebtedness is limited in amount, as explained in this chapter.
When refinancing pre-October 14, 1987, mortgage debt, the amount that exceeds the existing debt, does not qualify as grandfathered debt. The excess may be treated as home acquisition or home equity indebtedness, but the total qualifying indebtedness cannot exceed the fair market value of the residence. Grandfathered debt refinanced after October 13, 1987, generally retains its status as grandfathered debt only for the remaining term of the original debt.
An original mortgage note incurred prior to October 14, 1987, to purchase a qualified residence had been reduced to $100,000 in 2014, when the value of the residence was $175,000. If this mortgage is refinanced, $100,000 of the new mortgage note is treated as grandfathered debt. Up to $75,000 may be treated as home acquisition or home equity indebtedness. If the indebtedness exceeds the value of the residence ($175,000), the excess must be allocated in accordance with the use of the excess amount.
Mortgages you took out after October 13, 1987, to buy, build, or improve your home (called home acquisition debt), but only if throughout 2014 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 2014 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 benefits of home equity loans. Many taxpayers are taking home equity loans as a means of paying off their credit card balances, automobile loans, and other types of consumer expenditures. There are two major benefits of home equity borrowing:
Interest on up to $100,000 of home equity loans ($50,000 if married filing separately) is tax deductible for federal income tax purposes, whereas personal interest is not. Home equity loans are less expensive than other types of credit. For example, the rate for home equity loans may be 7% or less. In comparison, the interest rates for credit cards and unsecured personal loans can exceed 18%. Although home equity loans present several benefits, you should remember that if you are unable to pay off the loan, your house is in jeopardy—not the items that you purchased with the borrowed funds. In addition, not all home equity debt interest is deductible for alternative minimum tax purposes.
The dollar limits for the second and third categories apply to the combined mortgages on your main home and second home.
See Part II of Publication 936 for more detailed definitions of grandfathered, home acquisition, and home equity debt.
You can use Figure 24-A
According to the IRS, the fair market value of your home cannot be less than the adjusted purchase price on the last day of the taxable year.
John Joyce purchases a home in August 2014 for $150,000. He makes improvements costing $10,000 to the home during 2014, but these improvements add only $5,000 to the value of the home.
Although the value of the home at the end of 2014 is only $155,000, John is allowed to use $160,000, the cost of the home plus improvements, as the fair market value.
Figure 24-A
A second home also may be a qualified residence. A second home may be one that you do not occupy, a home that you occupy part of the year, or a home that you rent out. If the home is rented out, it is subject to the use requirements relating to vacation homes. It qualifies as your home only if you used it more than the greater of:
4 days, or 10% of the number of days during the year that it was rented at a fair rental or held out for sale. If a dwelling is not rented at any time during the year, it may be treated as a qualified residence, even if it is not used by you. For this purpose, the IRS states that “rented” includes holding the residence out for rental or for resale.
Mary owns a vacation home in northern Michigan. Because of business pressures, she is unable to use the home in 2013 or 2014 and lists the home for sale on October 31, 2014.
The house qualifies as a residence in 2013. It is not considered her residence in 2014, because Mary did not use the house for more than the greater of 14 days or 10% of the number of days it was held out for sale (10% × 61 days = 6 days).
Limits on deduction. You cannot fully deduct interest on a mortgage that does not fit into any of the three categories listed earlier. If this applies to you, see Part II of Publication 936 to figure the amount of interest you can deduct.
This section describes certain items that can be included as home mortgage interest and others that cannot. It also describes certain special situations that may affect your deduction.
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 performed 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.
Sale of home. If you sell your home, you can deduct your home mortgage interest (subject to any limits that apply) paid up to, but not including, the date of sale.
Example. John and Peggy Harris sold their home on May 7. Through April 30, they made home mortgage interest payments of $1,220. The settlement sheet for the sale of the home showed $50 interest for the 6-day period in May up to, but not including, the date of sale. Their mortgage interest deduction is $1,270 ($1,220 + $50).
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. You can deduct in each year only the interest that qualifies as home mortgage interest for that year. However, there is an exception that applies to points, discussed later.
When Dan borrowed $10,000 on a mortgage on November 1, 2014, he prepaid 16 months of interest ($1,600). The $1,600 of prepaid interest is considered to be paid, and therefore deductible, equally over the 16-month period ($100 per month). Dan should deduct $200 in 2014, $1,200 in 2015, and $200 in 2016.
On March 26, Eric signed a mortgage note for $12,000 and agreed to repay it in 12 equal installments, beginning on April 1. Interest of $960 was subtracted from the face value of the note, and Eric received $11,040. If Eric uses the cash method of accounting, as most people do, interest is considered to be paid in 12 installments of $80 each ($960 ÷ 12). Eric may deduct $720 ($80 × 9 months) for the first year and $240 ($80 × 3 months) in the following year.
No deduction is permitted for the interest if payment for an installment period is not made. Therefore, if Eric were to miss two installment payments in the first year, he could deduct only $560 ($80 × 7 months).
Mortgage interest credit. You may be able to claim a mortgage interest credit if you were issued a mortgage credit certificate (MCC) by a state or local government. Figure the credit on Form 8396, Mortgage Interest Credit. If you take this credit, you must reduce your mortgage interest deduction by the amount of the credit.
For more information on the credit, see chapter 37
Ministers’ and military housing allowance. If you are a minister or a member of the uniformed services and receive a housing allowance that is not taxable, you can still deduct your home mortgage interest.
Hardest Hit Fund and Emergency Homeowners’ Loan Programs. You can use a special method to compute your deduction for mortgage interest and real estate taxes on your main home if you meet the following two conditions.
You received assistance under:A State Housing Finance Agency (State HFA) Hardest Hit Fund program in which program payments could be used to pay mortgage interest, or An Emergency Homeowners’ Loan Program administered by the Department of Housing and Urban Development (HUD) or a state. You meet the rules to deduct all of the mortgage interest on your loan and all of the real estate taxes on your main home. If you meet these tests, then you can deduct all of the payments you actually made during the year to your mortgage servicer, the State HFA, or HUD on the home mortgage (including the amount shown on box 3 of Form 1098-MA, Mortgage Assistance Payments), but not more than the sum of the amounts shown on Form 1098, Mortgage Interest Statement, in box 1 (mortgage interest received from payer(s) / borrower(s)), box 4 (mortgage insurance premiums) , and box 5 (real property taxes). However, you are not required to use this special method to compute your deduction for mortgage interest and real estate taxes on your main home.
Mortgage assistance payments under section 235 of the National Housing Act. If you qualify for mortgage assistance payments for lower-income families under section 235 of the National Housing Act, part or all of the interest on your mortgage may be paid for you. You cannot deduct the interest that is paid for you.
No other effect on taxes . Do not include these mortgage assistance payments in your income. Also, do not use these payments to reduce other deductions, such as real estate taxes.
Divorced or separated individuals. If a divorce or separation agreement requires you or your spouse or former spouse to pay home mortgage interest on a home owned by both of you, the payment of interest may be alimony. See the discussion of Payments for jointly-owned home chapter 18 .
Redeemable ground rents. If you make annual or periodic rental payments on a redeemable ground rent, you can deduct them as mortgage interest.
Payments made to end the lease and to buy the lessor’s entire interest in the land are not deductible as mortgage interest. For more information, see Publication 936.
Nonredeemable ground rents. Payments on a nonredeemable ground rent are not mortgage interest. You can deduct them as rent if they are a business expense or if they are for rental property.
Reverse mortgages. A reverse mortgage is a loan where the lender pays you (in a lump sum, a monthly advance, a line of credit, or a combination of all three) while you continue to live in your home. With a reverse mortgage, you retain title to your home. Depending on the plan, your reverse mortgage becomes due with interest when you move, sell your home, reach the end of a pre-selected loan period, or die. Because reverse mortgages are considered loan advances and not income, the amount you receive is not taxable. Any interest (including original issue discount) accrued on a reverse mortgage is not deductible until the loan is paid in full. Your deduction may be limited because a reverse mortgage loan generally is subject to the limit on Home Equity Debt discussed in Publication 936.
Rental payments. If you live in a house before final settlement on the purchase, any payments you make for that period are rent and not interest. This is true even if the settlement papers call them interest. You cannot deduct these payments as home mortgage interest.
Mortgage proceeds invested in tax-exempt securities. You cannot deduct the home mortgage interest on grandfathered debt or home equity debt if you used the proceeds of the mortgage to buy securities or certificates that produce tax-free income. “Grandfathered debt” and “home equity debt” are defined earlier under Amount Deductible .
Refunds of interest. If you receive a refund of interest in the same tax year you paid it, you must reduce your interest expense by the amount refunded to you. If you receive a refund of interest you deducted in an earlier year, you generally must include the refund in income in the year you receive it. However, you need to include it only up to the amount of the deduction that reduced your tax in the earlier year. This is true whether the interest overcharge was refunded to you or was used to reduce the outstanding principal on your mortgage.
If you received a refund of interest you overpaid in an earlier year, you generally will receive a Form 1098, Mortgage Interest Statement, showing the refund in box 3. For information about Form 1098, see Form 1098, Mortgage Interest Statement
For more information on how to treat refunds of interest deducted in earlier years, see Recoveries chapter 12 .
936 Home Mortgage Interest Deduction
550 Investment Income and Expenses 