As a general rule individuals cannot take a deduction for personal interest payments. There are six exceptions to this general rule and the one homeowners are probably most familiar with is the deduction for home mortgage interest payments.
Although the law does provide for the deduction of home mortgage interest, the deduction is not without limits. It must comply with the following basic requirements:
- The deduction can only be taken for qualified residence interest which is defined as interest that is paid on acquisition indebtedness or home equity indebtedness with respect to the qualified residence.
- Acquisition indebtedness is debt incurred in acquiring, constructing, or substantially improving the qualified residence and which is secured by such residence. It also includes indebtedness resulting from refinancing if the amount of the indebtedness resulting from such refinancing does not exceed the amount of the refinanced indebtedness.
Home equity indebtedness is debt, other than acquisition indebtedness, secured by a qualified residence in an amount not to exceed the fair market value of the residence less the acquisition indebtedness.
3. The total amount of the acquisition indebtedness for any period cannot exceed $1,000,000.
4. The total amount of the equity indebtedness for any period cannot exceed $100,000.
So what’s the big deal you ask? Well, the Joint Committee on Taxation estimates that for the years 2016 to 2020 the mortgage interest deduction on owner-occupied homes will cost the government $357 billion. With that in mind the law required that changes be made to Form 1098. This form, which lenders must send to the IRS, reports the interest a homeowner paid to the lender during the year.
The revised Form 1098 requires the lender to report the date on which the mortgage was obtained, the principal balance on the mortgage and the address of the property securing the mortgage. Armed with this new information the IRS will now have the ability to determine whether the mortgage balance is above the $1,000,000/$100,000 limitations. It will also be able to determine whether the property securing the mortgage is a qualified residence.
Possibly the taxpayer who may be most at risk with the amended Form 1098 is the homeowner who refinances his/her home for more than is owed on the acquisition indebtedness and uses the excess for expenses other than buying, building or improving the home. Although the total amount of the new mortgage may fall below the $1,000,000 limitation, for purposes of determining the interest deduction the amount of the new mortgage must be reduced by the actual amount due on the acquisition indebtedness at the time of the refinancing. If the equity indebtedness portion of the refinanced mortgage is above $100,000 the interest deduction may be limited.
Although one can never know for sure what the IRS will do with the new information now required to be included in Form 1098, it should be safe to assume that it will not pass up an opportunity to more carefully scrutinize the home mortgage interest deduction on returns. With that in mind be aware that even though the Form 1098 issued by a lender may report the total amount of interest paid by the taxpayer, that does not mean that the amount is fully deductible. If in doubt, it is always best to consult a tax professional.
The above is a general overview of the mortgage interest deduction. The law provides for other exceptions and applications which may apply to your particular situation.