Tax Deductions and Mortgages

Manage Your Mortgage and Tax Deductions

Mortgage loans are long-term commitments. To put yourself in the best financial position, you need to:

• Prepare in advance to qualify for a mortgage,
• Shop around for the best mortgage terms
• Make your mortgage payments on time, including your homeowner’s insurance and property taxes.

You also need to be aware of how your mortgage affects your tax situation. Mortgage tax deductions, like any part of the tax code, can change over time, so consult with an expert tax professional to find out how the relevant tax regulations affect you.

Some of the tax deductions relate to taking out your loan and some relate to paying back your loan. Here are the main mortgage tax deduction areas you need to know about:

• Mortgage Interest Tax Deduction
• Mortgage Points Tax Deduction for Home Purchase Mortgage and Refinance Mortgage
• Mortgage Insurance Tax Deduction

Mortgage Interest Tax Deduction

If you have a mortgage loan for a qualified residence, then you can consider using the interest portion of your payment as part of your itemized deductions on your tax return. If you paid more than $600 in mortgage interest, you lender is required to send you a 1098 Mortgage Interest Statement that lists the total amount of interest you paid for the year.

Qualified residences include your principal residence (main home) or second home. According to the IRS, the home must have sleeping, cooking and toilet facilities and can be a"‘house, co-op, condominium, mobile home, house trailer or houseboat." A vacation home that is not rented out may also be eligible for qualified residence status.

The amount of interest is limited based on the time you took the loan and the amount of the debt. Here are a few general rules for post-October 13, 1987 mortgage loans:

• Acquisition debt or mortgages to buy, build or improve your home are limited to $1 million (or $500,000 if married filing separately)
• Home equity debt up to $100,000 (or $50,000 if married filing separately).

An Example: A couple with a $400,000 mortgage at 4% is paying about $16,000 of mortgage interest. Let’s assume that their tax rate is 25%. The standard deduction for a married couple filing jointly is $11,600. However, using the itemized deduction, and just counting the mortgage interest the couple can claim the full $16.000 interest payment. Their real saving will be any amount over the full deduction. If they only have mortgage insurance to deduct their savings would be$1,100 as follows:

• Regular deduction: $11,600
• Mortgage Interest to deduct: $16,000
• Difference: $ 4,400
• Tax Savings $ 1,100
• Tax bracket: 25%

It is important to check with a tax professional to make sure that the mortgage interest and other items (such as charity donations) qualify for the itemized status.

Mortgage Points Tax Deduction

When you take out a mortgage loan, you are often charged lender fees and points (origination and discount points). Those points are considered financial costs, and you may be able to claim them on your itemized deductions. The rules for qualification are similar to those of qualified interest, as explained above.

The rules regarding when you can deduct the fees are detailed and can be confusing. Consult with a tax professional to determine your eligibility and ensure that you calculate the deductible amount properly. In general, points that you pay (as a percentage of the loan) for a mortgage loan, used to purchase or improve your main home are deductible in the same year paid.

Points paid toward refinance loans (if no funds are used to improve the property) and loans for second homes are generally deducted over the life of the loan. The most common method to calculate your yearly deduction is to divide the total fee paid by the total amount of monthly payments in your loan. You can than prorate the fee amount for the number of months you paid the loan during the tax year you are filing for. For a purchase loan, if you prepay the loan, then you can claim the remaining un-itemized amount in the year the payment was made. If you refinance, then spread the remaining amount over the time of the new loan (in addition to any new points you pay).

Here are the IRS rules regarding deductions when your mortgage is paid-off early:

"If you spread your deduction for points over the life of the mortgage, you can deduct any remaining balance in the year the mortgage ends. However, if you refinance the mortgage with the same lender, you cannot deduct any remaining balance of spread points. Instead, deduct the remaining balance over the term of the new loan."

IRS Publication 936 has more detailed information regarding the types of loans that qualify, when you can deduct the paid fees, and how to calculate the deduction.

Mortgage Insurance Premium Deductions

If you pay for VA, FHA, RHA (Rural Housing Authority) or private mortgage insurance for a qualified house, then you may be eligible to deduct your mortgage insurance premiums, at least through 2011.

There is an adjusted gross income limitation to be eligible for the qualification, as follows:

• Less than $100,00 ($50,000 if married filing separately) full deduction
• More than $100,000 (half of that amount if married filing separately): reduced
• More than $109,000 ($54,000): no deduction

You can allocate the deduction based on the time you make the payments, except for prepaid insurance, which is allocated until the stated term of the loan or 84 months, the shorter of the two periods.

Since the tax deduction expired in March 2012, it remains to be seen if the deduction will be eligible for the tax year 2012. On August 1, 2012 Sen. Debbie Ann Stabenow [D-MI] introduced bill S. 3740 proposing to permanently extend the tax deduction on mortgage insurance. Make sure that you consult with your tax prepare before claiming any deductions.

Mortgage Tax Deductions - A Big Deal?

Some borrowers reap the greatest tax savings by itemizing their deductions, instead of using the standard deduction. Itemized deductions include your mortgage interest, mortgage insurance, and mortgage fees.

For many borrowers, the net gain from itemizing is negligible. Your gains are only the amount you itemize over the standard deduction. Currently the standard deduction for a single filer is $5800 and for a married jointly filer $11,600.) Besides mortgage tax deductions, other itemized deductions include qualified charitable donations, medical expenses that meet the IRS standards, and real estate taxes.

For borrowers with large mortgages, the tax savings can be significant; however, for the average borrower, the savings may not be large.

Romney’s suggestion to limit the amount of itemized deductions will most certainly affect the affluent more than the middle class borrower. Although the housing industry has fought against eliminating the mortgage deduction, it is not clear that a cancelation of limitation of the deduction will hurt the housing market.

Although the tax deduction does put more money back into the pockets of the borrower, it is unlikely that homeowners purchase property because of the potential savings in their tax bill. Regardless of the tax policy in place regarding the mortgage interest deduction, make sure that you can afford the monthly mortgage payments, before you take a loan. Also, speak to a professional tax preparer, before you file your taxes.