A mortgage is defined as any obligation secured by real property, which is land and anything built on it. Mortgage interest paid for a personal residence is deductible for individual federal income tax purposes. A personal residence to the IRS includes everything from “Downton Abbey” to a manufactured home with a minimum living space of 400 square feet. So, those Americans who prefer a house boat, motor home or “tiny” house may still be entitled to a deduction for interest paid as long as the residence has sleeping space, cooking and toilet facilities, and the borrower uses it as a home, even with the absence of land.
If you paid more than $600 in mortgage interest for your personal residence, you will most likely receive a Form 1098 from your lender. However, if you have the untraditional home or an untraditional mortgage and do not receive Form 1098 from a lending institution you may still be entitled to a deduction for qualifying home mortgage interest. The home mortgage deduction is allowed for your main home and a second home and is claimed as an itemized deduction on Schedule A of Form 1040.
If all your home mortgages were taken out on or before October 13, 1987 your interest if fully deductible. For debt incurred after October 13, 1987, the rules get more complicated and additional consideration must be given.
Home Equity Debt after October 13, 1987
Debt incurred after October 13, 1987 and greater than $100,000 is divided into “acquisition debt” and “home equity debt”. Acquisition debt occurs when the funds are used to buy, build or substantially improve your home. You can fully deduct interest paid on acquisition debt that has a balance of not more than $1,000,000 or $500,000 for married filing separate (MFS).
Home equity debt occurs when funds are used for any purpose other than “acquisition debt”. When your total home equity debt balance exceeds $100,000 ($50,000 MFS) at any time during the year, limitations apply to the deductibility of the interest. Also, the total home equity debt cannot exceed the home’s fair market value. Interest on home equity debt greater than the fair market value of the home is considered personal interest and is not deductible.
Who Gets the Deduction?
Sometimes multiple parties are involved in home financing arrangements. For instance, parents who take out a mortgage and purchase a home for their grown child who can’t get a mortgage on their own. If the child makes all the mortgage payments, who gets the interest deduction?
First, consider who actually paid the mortgage interest. You cannot claim a deduction for interest that you never actually paid. This prevents the parents from claiming the interest deduction even though they received the 1098 Form. However, this doesn’t mean the child is automatically allowed the deduction. The child must satisfy at least one of three additional criteria before they are entitled to the deduction. The child must either be legally obligated to pay the mortgage debt, have legal title to the property or be an “equitable owner” in the property. In general, an “equitable owner” is someone who inures the same benefits and risks of a legal owner. In the above example, the child does not have a legal obligation to pay the debt nor do they legally own the property. So, the child’s ability to deduct the mortgage interest hinges on whether they are considered an “equitable owner”.
New for 2016
You may notice some differences on the Form 1098 that you received this year. The form has been modified to comply with provisions of the Surface Transportation and Veterans Health Care Choice Improvement Act of 2015. It now includes the address or description of the property, the balance of the outstanding mortgage on January 1, 2016 and the mortgage origination date.