Deducting Interest on Your Second Mortgage

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Deducting Interest on Your Second Mortgage

The federal government is aware that for many Americans, a mortgage is the biggest financial commitment they will ever make. The Internal Revenue Service (IRS) permits taxpayers to deduct the interest paid on their mortgages in order to give taxpayers a break (and presumably to encourage them to engage in the real estate market).

But what if you take out a second mortgage on your house? What purpose you utilize it for really matters? Is it possible to just deduct interest forever?

We’ll go into great detail on the financial repercussions of getting a second mortgage, including how to calculate your tax deduction and a list of limits and risks.

How to Deduct Interest on a Second Home: The Basics

In order to qualify for a mortgage interest deduction, you must first understand what qualifies as a “qualifying residence” and how the IRS defines “mortgage debt” and “mortgage interest.”

To begin with, a “qualifying house” is either your primary residence, where you ordinarily reside, or a second residence. According to IRS Publication 936, as long as they contain “sleeping, cooking, and bathroom facilities,” mobile homes, house trailers, flats, and boats all qualify.

You may only list two properties as your main and secondary residences for a given year if you own three or more. You may designate another property as your primary or second home for the remainder of the year if you happen to sell one of the residences you were claiming during that year.

There are complex procedures and calculations that must be made in order to claim deductions for a house that serves as both a residence and another purpose, such as a rental property or an office, depending on how much time you spend there. You may refer to details here, but generally speaking, in order to be eligible to write off the interest on a second home’s mortgage, you must reside there for at least 14 days out of the year, or for more than 10% of the time it is leased out, whichever is longer.

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Only interest on loans when your house or homes are used as collateral are subject to mortgage interest. This comprises:

Three types of mortgage debt are described by the IRS. These change based on when the loan was taken out and what the money was spent for:

  • Mortgages that were secured by your house on or before October 13, 1987 are referred to as legacy debt (after which current tax rules took effect).
  • Mortgages obtained after October 13, 1987, and used to purchase, develop, or upgrade a property are referred to as “home acquisition debt” (i.e.., renovations, repairs, etc.).
  • Mortgages obtained after October 13, 1987 that were utilized for other, non-residence-related purposes—such as to pay for college tuition, a new automobile, a vacation, or pretty much anything else unrelated to purchasing, constructing, or upgrading a home—are referred to as home-equity debt or loans.

Origination points and discount points are the two kinds of points used in the home mortgage market. Discount points are a sort of prepaid interest and are often entirely deductible, while origination points are normally money for the loan originator.

How Much Mortgage Interest Can You Deduct?

That depends on the kind of debt you currently have and the amount of additional debt you intend to take on. If you are married and file jointly, you may only deduct interest on home equity debt totaling $100,000 or less and debt used to purchase a property totaling $1 million or less. Your limitations increase to $500,000 for house purchase debt and $50,000 for home equity debt if you’re single or married but filing separately. You may see the effect of various rates on your monthly payment with a mortgage calculator.

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In other words, you may deduct all of your interest payments if your mortgage or mortgages total $1 million and were used to acquire, develop, or enhance your main and/or second home (making it home acquisition debt). For instance, if you pay $40,000 in interest year on two mortgages with 4% interest rates totaling $1 million, you may write off the whole amount. You may see the effect of various rates on your monthly payment with a mortgage calculator.

However, if your debt for buying a house is, say, $2 million, you would only be eligible to write off half of the interest you paid on $2 million in mortgages that year. You could only deduct $40,000 instead of the $80,000 you probably paid in interest that year if the same 4% interest rates were in effect.

Even though there is no cap on legacy debt, if your legacy debt totals more than $1 million, you won’t be able to deduct any more from future mortgages. What if your legacy debt is merely $900,000? Then, you could only write off interest on an extra $100,000 in debt for buying a property.

This is the general norm, at least. To calculate your real deductible home mortgage interest, the IRS offers a worksheet.

Second Mortgage Interest Deduction Tax Forms

You’ll get a letter from your mortgage holder or lender (often Form 1098) a few months before tax filing season if you’ve paid at least $600 in mortgage interest. This Mortgage Interest Statement will display the amount of your yearly payments as well as the amount of your paid mortgage insurance premiums and deductible points (if you purchased a home that year).When you have this document in your possession, utilize Schedule A on Form 1040 to complete your tax return (Itemized Deductions).

The total amount of debt you may borrow against your property is $1.1 million when you combine loans for home equity and home purchasing. But if you happen to have extra debt that exceeds this cap, you may be eligible to deduct the interest if the money was used for a qualifying item, such a company or investment (which is also shown on Schedule A) (Schedule C or C-EZ).

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Refinancing, Points and Premiums

If you refinance any mortgage, even your second one, you may deduct the new loan’s principal amount as house purchase debt. Anything more is considered home equity debt.

In addition, you may write off points you pay for the new mortgage during the course of the loan. If you refinance into a new 30-year mortgage, you may subtract 1/30 of the points you paid each year. When you sell or refinance your home (again), if you haven’t already subtracted all of the points, you may do so at once in that year. The deduction should be entered on Schedule A, line 12 of Form 1040.

You may deduct part or all of your mortgage insurance costs as long as your adjusted gross income doesn’t go above $109,000 (or $54,500 if you’re married and filing separately). This would be considered “home purchase debt.”

The Bottom Line

There is no doubting that the tax laws are complex, but if you follow the rules correctly, you might end up saving tens of thousands of dollars annually. Before you decide to take out a second mortgage, be sure to speak with a licensed tax specialist.

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