Home Mortgage Interest Deductions


If you own a home, the interest you pay on your home mortgage provides one of the best tax breaks available. However, many taxpayers believe that any interest paid on their home mortgage loan is deductible. Sadly, they’re wrong. With home prices skyrocketing in many states, now’s a good time to revisit the interest deduction rules for home mortgages and home equity loans.

It used to be the case that pretty much all interest payments were deductible. Since 1986, however, deductibility has become very complicated. Personal interest is disallowed, but one kind of interest that remains deductible is qualified residence interest. Qualified residence interest is interest incurred from buying, building, or improving your qualified residence, or from home equity loans on that residence. You can deduct interest from up to two qualified residences: your primary home and one other vacation home or similar property. You cannot deduct mortgage interest with respect to a third residence.

However, this deal comes with strings attached. You can’t deduct the interest for acquisition debt greater than $1 million ($500,000 for married individuals filing separately). So, for example, if you were to buy a $2 million house with a $1.5 million mortgage, only the interest that you pay on the first $1 million in debt will be deductible. The rest will be considered personal interest.

Note also that the $1 million ceiling on deductible home mortgage debt includes both your primary residence and your second home combined. Too many taxpayers assume that they can deduct $1 million from each mortgage. But if you have a $700,000 mortgage on your primary home and a $500,000 mortgage on your beach house or ski lodge, you’ll have to count $200,000 of the total as nondeductible personal interest.

The rules are different for home equity loans. Home equity debt is debt (other than acquisition debt) secured by your principal or second residence. Home equity debt is limited to the lesser of $100,000 ($50,000 if your filing status is married filing separately) or your equity in the home. The interest that you pay on a qualifying home equity loan is generally deductible regardless of how you use the loan proceeds, except when the proceeds are used to purchase tax-exempt obligations.

This provides some real savings opportunities if you have equity in your home and also have other debts. Credit card debt is not deductible and usually carries a higher interest rate than home equity interest. By converting your nondeductible, higher-rate, credit card debt to home equity indebtedness (i.e., use the home equity loan to pay off your credit card balance), you will save both on taxes and on the interest rate.

However, you should bear in mind that interest on a home equity loan isn’t deductible for purposes of the alternative minimum tax (AMT), unless you use the loan to improve your home. This is an important consideration, since an increasing number of taxpayers are subject to the AMT.


Employer-paid educational assistance

A tax break allows an employee to receive up to $5,250 a year of tax-free educational assistance under an employer’s educational assistance program. (There are technical rules that prevent too many of these benefits from going to company owners and highly compensated employees.) The beauty of this tax break is that it applies to just about any kind of course or program, including any graduate level course, even if it isn’t job-related. However, the tax break isn’t available for courses relating to sports, hobbies, or games (unless they’re a required part of a degree program or relate to your employer’s business).

If your employer will pay for your courses through a qualified educational assistance program your benefits will be tax-free. Besides tuition, this tax-free assistance can cover related fees, books, and supplies. However, you cannot receive tax-free advances or reimbursements under the plan for tools or supplies (other than textbooks) that you can retain after the course ends, or for meal, lodging, or transportation costs.

If your employer-paid educational benefits aren’t from an educational assistance plan, they still may be tax-free if a number of conditions are met. The education must be job-related. That is, it must help you maintain or improve your employment skills, or be required for you to keep your job, your salary level, or your current status. The education cannot, however, enable you to meet the minimum qualifications for your job, or qualify you for a new trade or business.

In order to receive educational expense advances or reimbursements tax-free, you must substantiate the expenses to your employer, and you must be required to return any excess amount that your employer may have advanced to you.