How Mortgage Interest Tax Deductions Work

Buying a home is a great way to reduce your income tax. The mortgage interest you pay and your real estate taxes are both tax deductible. You can deduct the interest on your home loan and the real estate taxes you pay on the home. Mortgage interest is tax deductible on loans of up to $ 1 million ($ 500,000 if married filing separately) as long as you use the money to buy, build or improve on your home and the loan is secured by your home. Points or origination fees paid when you purchase your home are generally tax deductible in full in the year that you pay them. The mortgage interest deduction and the real estate tax deduction are two of the most important preferences for homeowners in the federal income tax code. The deductions promote homeownership and reduce tax liabilities for home-owning taxpayers. Additionally, eligible first time homebuyers may claim a refundable credit for a home purchased after April 8, 2008 and before May 1, 2010.

Home Equity Loans

The mortgage interest tax deduction also applies to home equity loans. Accordingly, borrowers may get a tax deduction on interest paid for the loan. You should understand however, that the tax deduction is not unlimited. The interest deduction from your home equity loan is not unlimited. You can generally deduct interest you pay on the first $100,000 of a home equity loan. After that, it depends. If the home equity loan was used to improve your first or second home – or to purchase a second home – you can probably take the deduction on an amount up to $1 million or the value of the home.

Refundable First-time Homebuyer Credit

Individuals who purchased a principal residence from an unrelated party at fair market value after April 8, 2008, and before Jan. 1, 2009, and who did not own a principal residence during the 3-year period ending on the date of purchase may claim a refundable tax credit for 10% of the purchase price. The maximum credit is $7,500 ($3,750 Married Filing Separately). The credit is reduced when modified adjusted gross income (AGI) exceeds $75,000 ($150,000 if Married Filing Jointly) and is eliminated when modified AGI reaches $95,000 ($190,000 if Married Filing Jointly).

The tax credit is repaid in 15 equal installments starting in 2010. Repayment is accelerated if the home is sold or no longer used as a principal residence. However, the amount required to be repaid for a sale to an unrelated party is limited to the gain on the sale. Taxpayers whose home financing comes from tax-exempt revenue bonds may not claim the credit.

Conclusion

Tax laws are complex and they change often. If you’re thinking about taking a mortgage interest deduction as well as the applicability of the Homebuyer Credit, make sure it’s legal. The IRS Website is really pretty helpful. In addition, because of the changes, their applicability to your specific situation and the amounts involved, it’s necessary to consult with either a financial planner, CPA or a tax preparer.