Is Your Mortgage Tax Deductable?

What I'm about to discuss should not be considered tax advice, but simply my suggestion that you contact your tax preparer to discuss your paticular tax implications.

That being said, most people believe that no matter what type of mortgage, property, or reason, if it is a loan on a home it is tax deductable. That couldn't be further from the truth and you need to be aware your mortgage interest may not be deducatable.

The tax code (as I understand it) stipulates that for the mortgage interest to be deducable, it must be your primary home, or qualifying second home, and must be a mortgage obtained during the purchase (or within 90 days of the close) of said home. Loans taken out for capital improvements (improvements to your home) are also considered purchase money loans even if obtained years after the purchase. You are also afforded the opportunity to take a $100,000 home equity loan, of which you can do anything with the money.

To illustrate, lets say you bought a $200,000 home as your primary residence and financed 80% of the value. All of the interest from the $160,000 mortgage would be tax deducatable. Then two years later you obtain another mortgage for$320,000, "cashing out" $160,000. You spend $40,000 of that money remodeling the kitchen, bathroom, and family room. Then you spend $20,000 on a new boat.

In this scenario only the interest on $300,000 of the new loan would be tax deductable. That is because the original $160,000 purchase loan amount is deductable, plus the $40,000 you spent on capital improvements, as well as the $100,000 "home equity loan" allotment. The portion of this loan not deductable would be the money spent on the new boat.

You may be asking yourself how would the IRS know how you spent the money. Well quite simply, when the IRS audits you, the burden of proof is on you to prove the deducation is tax deductable. That means you must provide proof of where you spent the money "cashed out" of the equity in your home. If you can't prove it was spent on a capital improvement, then you never did. I know you have heard it before, but keeping receipts is vital.

If the IRS determines you took a deduction without proof or without a legal reason, they will assess penalties and late fees on the amount of tax you are liable for. This is the exact reason it is detremental to work with professionals.

In closing, I must reinterate that you should counsel with a tax professional. As I mentioned before, tax laws change all of the time, so what I wrote in this blog may not be entirely accurate. I try to keep up with the changes, but my specialty is mortgage lending.