2009 Tax Deduction Overview of Mortgages

1) Guidelines on Qualifying for the Deduction:

You must file a form 1040 and itemize deductions on schedule A (note for 2009 you may need to reduce the amount of itemized deductions if your AGI exceeds $166,800).

You must be legally liable and obligated to pay the mortgage.

You have a legitimate debtor-creditor arrangement with the lender.

The mortgage is secured debt against a qualified property for which you have an ownership interest in.

2) Interest Treatment is based upon the Closing Date:

Mortgages closed before or on 10-13-1987 – the best possible scenario, you can deduct the full amount of interest paid regardless of use. This is considered grandfathered debt.

The tax treatment after mid-October of 1987 depends upon whether the mortgage is considered “acquisition (or purchase) debt” used to purchase, build or improve the home or “equity debt” which draws down the equity reserve of the home. In any event the maximum interest allowed for deduction is $1.1 million on a primary residence and a qualified second home:

Mortgages closed after 10-13-1987 – up to $1 million can be deducted for married joint filers and $500,000 for single filers and married but separate filers. Interest on a mortgage which was used to purchase, build or improve the home may be fully deducted up to the above mentioned amount.

Home Equity Debt after 10-13-1987 – up to $100,000 can be deducted on a mortgage used for purposes other than purchasing, building or improving the home.

3) Deducting Points Paid:

Note: points paid on a mortgage may frequently be referred to as loan origination fees, discount points or loan discount fees.

Points, regardless of the name applied, are essentially pre-paid interest on a mortgage and whether you can deduct the full amount of the points paid depends upon if the loan in question involved a purchase or refinance transaction and if a refinance, how the loan proceeds where used.

Purchase Points – typically fully deductible if the mortgage in question is secured by a primary residence (second homes and investment properties do not apply), the points paid were calculated as a percentage of the loan amount, the points paid were common and customary for the geographic area, the points paid were not paid in lieu of other customary loan fees, the points were paid at the time of closing and are accurately reflected on the Final Settlement Statement or (HUD-1).

Refinance Points – when paid in the course of a refinance transaction, points are generally required to be deducted (or amortized) over the life of the loan. Therefore on a 30 year refinance mortgage of $200,000 with 2 points paid at closing (totaling $4,000), the allowable deduction per tax year would be approximately $133 per annum. Typically this deduction can be accelerated at the time the loan is paid off.

Home Equity Loan Refinance Points - these points are fully deductible in the year they are paid only when the loan proceeds are used exclusively for purposes of improving a primary residence. If only a portion of the proceeds of the loan are used for home improvement purposes, then the pro-rated portion or percentage of the points directly associated with the improvements of the home can be deducted.

4) Additional Miscellaneous Mortgage Deductions:

Mortgage Late Payments – can be deducted as mortgage interest if the associated charge is not related to the performance of an actual service by the lender or loan servicer.

Mortgage Prepayment Penalty – considered deductible interest as long as the penalty is not related to the performance of an actual service performed by the lender or loan servicer.

Mortgage Insurance Premiums – for mortgage insurance contracts issued in connection with a home purchase after 2006, qualified mortgage insurance may be treated as mortgage interest and therefore is generally considered deductible.

Reverse Mortgages – funds a homeowner receives from a reverse mortgage are considered loan advances, not income, therefore the amount received is not taxable. Interest accrued on a reverse mortgage is not deductible until the loan is actually repaid by the qualified senior or the property is sold.

5) Circumstances Relating to the Distressed Economy:

Cancelled (or Forgiven) Mortgage Debt – The Mortgage Forgiveness Debt Relief Act of 2007 states that taxpayers need not claim as income the amount of debt discharged by their lender in association with a foreclosure or restructuring of their mortgage on their primary residence. This exclusion applies only to forgiven or cancelled debt which was used for the purpose of purchasing, building or improving a primary residence. Mortgage debt forgiven after refinancing may also qualify for the exclusion if the previous mortgage balance which was refinanced was used to purchase, build or improve a primary residence. This relief applies only to debt secured by a taxpayer’s primary residence (no investment properties or second homes allowed) and should result from a decline in the value of the home or a deterioration of the taxpayer’s financial condition. This exception applies to mortgage debt forgiven between the years 2007 through 2012 and up to $2 million in debt may qualify. The amount of debt forgiven is then deducted from the cost basis of a taxpayer’s home. The lender is normally required to issue a form 1099-C indicating the amount of the cancelled debt. See IRS publication 982 for more information.

The First-Time Home Buyer Tax Credit – a part of The Housing and Economic Recovery Act of 2008 and applies to qualified “first time buyers” for a home purchased as a primary residence between April 8, 2008 and April 30, 2010. Note that under the program a first time buyer is defined as someone who has not owned a primary residence in the prior 3 year period. Second homes and investment properties do not qualify for the credit. The credit is claimed on IRS Form 5405. For a purchase completed in 2009, the credit can be claimed on either the 2008 or 2009 tax return. For a purchase completed in 2010, the credit can be claimed on either the 2009 or 2010 tax return. The program was expanded and amended in 2009 eliminating the requirement initiated in 2008 which required repayment of the credit over a 15 year period. Repayment of credits issued in 2009 and 2010 is only required if the applicable residence does not remain the taxpayer’s primary residence for a minimum period of 36 months. The allowable credit is up to 10% of the purchase price of a home with a maximum credit of $7,500 in 2008 and $8,000 for homes purchased in 2009-2010. The program was expanded in late 2009 to include existing homeowners who purchase a new replacement residence after Nov. 6, 2009 through April 30, 2010 and are permitted a credit up to $6,500. For purchases on or prior to Nov. 6 2009, for married joint filers the income limit under the program is $150,000 to $170,000 and for single filers the limit is $75,000 to $95,000. On purchases occurring after Nov. 6, 2009 for married joint filers, the income limit is $225,000 to $$245,000 and for single filers $125,000 to $145,000.

Important Note: The information contained on this website is provided as a supplemental educational resource. Readers having legal or tax questions are urged to obtain advice from their professional legal or tax advisors. While the aforementioned information has been collected from a variety of sources deemed reliable, it is not guaranteed and should be independently verified.