THE MORTGAGE INTEREST LOOPHOLE
If you're a homeowner, you know you can deduct the interest on your mortgage. But the mortgage deduction can generate additional tax breaks.
Interest is the fee you pay for the use of someone else's money. But you can, in effect, lower that fee if you can write it off as a deduction on your taxes. Generally, that means finding a way to turn the interest into mortgage debt.
Deducting the interest on mortgage debt is America's favorite tax loophole. The amount deducted has been growing at an 8.5% rate since 1980 a reflection of rising property values.
And, as with anything else involving taxes, there are rules and stipulations you must know in order to claim the deduction. Mortgage and related debt but little else generates big tax breaks for taxpayers because it is always secured by the property. And you can buy a second home and deduct the mortgage interest (in addition to the real estate taxes on both properties) on it as well.
But whether you borrow the money from the bank or your rich cousin, you must be legally liable for the debt. As good as the mortgage deduction is, there is a limit to how much you can borrow and still be able to deduct the interest.
It’s the smaller of: The total cost to buy or build your home plus make any improvements, up to $1 million, or $500,000 in the case of a married individual filing a separate return. The cost of your house includes more than the amount paid to the seller. It also includes appraisal fees, title search, title insurance, transfer taxes, broker's commissions paid by the buyer, survey fees, bank or lender fees, legal fees, mortgage taxes, and any other nondeductible closing costs such as postage. It could also include the purchase of additional land adjacent to your home.
Home equity loans: Seize the opportunity
Since you can’t deduct interest on credit card loans and personal loans(consumer debt), home equity loans have become increasingly popular. That is because the interest on these loans, too, is deductible. Home equity indebtedness is any amount owed (other than the original acquisition mortgage debt) secured by a qualified residence. Interest on home equity debt is deductible to the extent the debt does not exceed $100,000 (or $50,000 for a married individual filing separately). (Technically, the limit is the home’s fair market value in excess of any outstanding home acquisition debt, with a $100,000 maximum. But, you’re rarely going to get a bank to lend more than the equity you have in the property.) Here's the beauty of home equity interest: How you use the money is irrelevant. Money can be borrowed for vacations, parties or to pay off other debt.
The deductibility of home equity interest provides substantial opportunity for sophisticated tax planning. The interest rate on home equity debt is usually calculated based on the current prime rate, plus one or two percentage points. If you own a home and owe several thousand dollars in credit card debt at rates of 18% to 21%, it would be a financial slam dunk to pay off that debt with a home equity loan. Not only would you pay a lower rate, but you could also write off the interest as a tax deduction.
