CARL WATTS & ASSOCIATES

December 14, 2015

www.carlwatts.com
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As much as it may seem like a truism, owning your own home is still the American dream. Once the dream becomes a reality, most of us are faced with the challenge of paying a mortgage with interest rates and all the rest. It may not be any news to you to find out that the interest you pay on your home mortgage is deductible.

If you want to find out more about deducting the interest paid on your home mortgage, as well as other kinds of deductible interest, just go on reading.

You should know that there are several types of deductible interest. Some types of interest are deductible on Schedule A of Form 1040 as itemized deductions, such as:

  • Investment interest (limited to your net investment income) and
  • Qualified mortgage interest including points (if you are the buyer).

Other types of interest are deductible elsewhere on the return, including:

  • Non-farm business interest (business interest expense is an amount charged for the use of money you borrowed for business activities);
  • Farm business interest;
  • Interest incurred to produce rents or royalties (which may be limited).

Your student loan interest may be deductible also as an adjustment to income.

Here is some basic information on the most common types of deductible interest.

Qualified mortgage interest is interest and points you pay on a loan secured by your main home or a second home. Your main home is where you live most of the time, such as a house, cooperative apartment, condominium, mobile home, house trailer, or houseboat. It must have sleeping, cooking and toilet facilities.

A second home can include any other residence you own and choose to treat as a second home. You do not have to use the home during the year.

However, if you rent it to others, you must also use it as a home during the year for more than the greater of 14 days or 10 percent of the number of days you rent it, for the interest to qualify as qualified residence interest.

Qualified mortgage interest and points are generally reported to you on Form 1098, Mortgage Interest Statement, by the financial institution to which you made the payments. The following mortgages yield qualified mortgage interest and you can deduct all of the interest on these mortgages:


  • A mortgage you took out on or before October 13, 1987 (grandfathered debt);
  • A mortgage taken out after October 13, 1987, to buy, build, or improve your home (called home acquisition debt) but only if throughout the year these mortgages plus any grandfathered debt totaled $1 million or less. The limit is $500,000 if you are married filing separately;
  • Home equity debt other than home acquisition debt taken out after October 13, 1987, up to a total of $100,000. The limit is $50,000 if you are married filing separately. Home equity debt other than home acquisition debt is further limited to your home's fair market value reduced by the grandfathered debt and home acquisition debt.


You may be subject to a limit (phaseout) on some of your itemized deductions including mortgage interest.

The term “points” is used to describe certain charges paid, or treated as paid, by a borrower to obtain a home mortgage. Points may also be called loan origination fees, maximum loan charges, loan discount, or discount points. A borrower is treated as paying any points that a home seller pays for the borrower's mortgage.
Deductible Interest
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You can deduct the home mortgage interest and points reported to you on Form 1098 on Schedule A of Form 1040, line 10. If you paid more deductible interest to the financial institution than the amount shown on Form 1098, show the larger deductible amount on line 10. Attach a statement explaining the difference and print “See attached” next to line 10.

If you borrow money to buy property you hold for investment, the interest you pay is investment interest. However, you cannot deduct interest you incurred to produce tax-exempt income. Nor can you deduct interest expenses on straddles.

Investment interest does not include any qualified home mortgage interest or any interest taken into account in computing income or loss from a passive activity.


Property held for investment includes property that produces interest, dividends, annuities, or royalties not derived in the ordinary course of a trade or business. It also includes property that produces gain or loss (not derived in the ordinary course of a trade or business) from the sale or trade of property producing these types of income or held for investment (other than an interest in a passive activity). Investment property also includes an interest in a trade or business activity in which you did not materially participate (other than a passive activity).

To determine investment interest for partners, shareholders, and beneficiaries., you have to combine your share of investment interest from a partnership, S corporation, estate, or trust with your other investment interest.

Generally, your deduction for investment interest expense is limited to the amount of your net investment income.

You can carry over the amount of investment interest that you could not deduct because of this limit to the next tax year. The interest carried over is treated as investment interest paid or accrued in that next year.

You can carry over disallowed investment interest to the next tax year even if it is more than your taxable income in the year the interest was paid or accrued.

You can deduct investment interest, subject to certain limits, on Schedule A of Form 1040, line 14.


Interest you pay on business loans is usually a currently deductible business expense. It doesn’t matter whether you pay the interest on a bank loan, personal loan, credit card, line of credit, car loan, or real estate mortgage. Nor does it matter whether the collateral you used to get the loan was business or personal property. If you use the money for business, the interest you pay to get that money is a deductible business expense.

If you use your car for business, you can deduct the interest that you pay on your car loan as an interest expense. You can take this deduction whether you deduct your car expenses using the actual expense method or the standard mileage rate, because the standard mileage rate was not intended to encompass interest on a car loan.

Some types of interest are not deductible at all. These include personal interest, which is any interest that is not home mortgage interest, investment interest, business interest, or other deductible interest. Non deductible personal interest includes:

  • Interest paid on a loan to purchase a car for personal use;
  • Credit card and installment interest incurred for personal expenses;
  • Points (if you are a seller), service charges, credit investigation fees, and interest relating to tax-exempt income, such as interest to purchase or carry tax-exempt securities.

Also, you cannot deduct fines and penalties paid to a government for violations of law, regardless of their nature.

There are, of course, special cases and exceptions to all of these rules, therefore, as always, it is our advice that help from a tax professional is your best option in all your dealings with the IRS.