When one buys a home and obtains a loan, the debt is called “acquisition indebtedness.” The interest on this loan is tax deductible up to one million dollars in debt. Interest on any amount above the one million debt limit is not deductible. If one borrows up to $100,000 in excess of the acquisition indebtedness, for any reason such as a home equity loan, the interest is still deductible. If debt is obtained above the one million limit and the home equity limit, it would not be deductible unless it was used to finance a business or income property. The percentage that applies to that venture would be deducted on the tax forms of that venture and not as home mortgage interest. This might mean a Sole Proprietor Schedule C, a rental Schedule E, or perhaps a corporation or LLC tax return. Accurate records must be kept to provide a clear paper trail for how the debt is portioned. By the way, interest on improvements, such as a room addition, landscaping, a pool, etc. are deductible within the one million limit plus 100k of home equity as explained before.
When purchasing a home points or discount fees are deductible. This fee will show up on the closing papers called a HUD 1 statement. These same fees are considered interest. If you are refinancing a loan, the points cannot be deducted in one year but over the life of the loan. When this happens, an amortization schedule is set up so that each year this small amount gets deducted. If you refinance again, the remainder of the old fees can be deducted all at once, and a new amortization schedule is set up for the points on the new loan.
Interest on a second home is deductible as well. The combined mortgage amount is limited to the one million total however. What qualifies as a second home? Any home with living accommodations can qualify. This would include a boat, mobile home, or RV as well. If the second home is rented out, it may qualify as a rental income property.
Rental properties require that all rental income is reported and all expenses related to the rental are deductible. So insurance, repairs, maintenance, cleaning, legal fees, home owner association dues, property management fees, advertising, etc. are also deductible. The Passive Loss limitations begin to kick in after your adjusted gross income exceeds one hundred thousand.
Interest on a business loan is deductible on the business tax forms. Interest on credit cards that are used exclusively for business are deductible. Using one credit card for both personal and business expenditures becomes too much trouble to prove the business use percentage and deduct that business percent of the interest. This would change from year to year. It is advisable to keep business uses of a credit card isolated to one card.
If you borrow money to purchase an investment such as stocks, mutual funds, annuities, bonds, etc. the interest is only deductible up to the amount of portfolio income you receive. Portfolio income would include interest, dividends, capital gains, royalties, etc. Interest on a loan to purchase tax free municipal bonds is not deductible.
If you are an employee, and already itemize deductions on Schedule A, you may be able to deduct the interest on a loan to obtain items needed in your business such as a computer, travel, office furnishings, home office furnishings, uniforms, equipment, cars, etc. if your employer will not provide or reimburse you for these items.
This covers the main circumstances when interest is deductible on a loan or credit card. Personal uses such as clothing, vacations, education, food, cars, furniture, etc. are not deductible. However, even with this list, if used for business, they may be deductible on Schedule A, form 2106, or Schedule C, whichever one is applicable in your circumstances.
For more information: Contact Allied Tax Planners
Author Bio
"Bradley L Haupt is a tax and financial advisor and started his firm Allied Tax Planners over 3 decades ago. His practice includes related services such as tax planning, tax preparation, and audit representation. Areas of specialization include tax-exempt organizations and small businesses.