Borrowing money leads to compounded interest charges. Interest is a fee added to the money you borrowed, and is generally charged for the length of repayment. In some cases, interest can either be deducted or claimed as a credit, however it has to meet certain qualifications.
Prepaid interest has to be deducted throughout the tax year in which the interest applies, as it is only eligible to be deducted during that specific year. If you paid in points for your primary residence, you may be able to claim an exemption.
Investment interest (limited to your net investment income) and qualified mortgage interest (including points) if you are the buyer should be itemized and claimed on Form 1040, Schedule A when you file your return.
Interest from rent or royalties, farm interest, and business interest not related to the farming industry are also deductible. Student loan interest is claimed as an adjustment to income on your tax return.
Personal interest, such as the following, is not deductible:
- Personal car loan interest
- Credit card interest
- Points for sellers, investigation fees or service charges
- Interest related to tax exempt income
You can be eligible to deduct interest through a credit if your local or state government issued a mortgage credit certificate. Mortgage interest that is backed by either your primary or secondary home can qualify for a deduction. Your primary home is where a majority of your time is spent and must have adequate cooking, sleeping and plumbing facilities.
A second residence can include any other home that you own. You don’t have to actually live in the home during the tax year, however rental property must be used as a home for either 14 days or 10 of the days its rented, depending on which is greater in order for it to qualify for a deduction.
You can report mortgage interest and points on a Form 1098, Mortgage Interest Statement, from your lender. You can deduct the complete interest on mortgages including:
- A mortgage taken before October 13, 1987
- A mortgage taken after October 13, 1987 used to purchase or renovate a home, typically known as home acquisition debt, as long as it is less than $1 million. Married, filing separately taxpayers have a limit of $500,000
- Home equity debt totaling up to $100,000 ($50,000 for married filing separately). Home equity debt is limited by the fair market value and reduced by the grandfathers and hoe acquisition debt.
You are able to claim mortgage interest as long as you itemize your deductions, though you are subject to certain imitations of itemized deductions.