Homeowners are generally in the best position to benefit from itemizing deductions on federal income taxes. As a homeowner, you can include mortgage interest and real estate taxes paid, in addition to other eligible deductions -- even from a second home -- but only if you itemize.
Qualified Mortgage Interest
For mortgage interest to be fully deductible, the mortgage must be used to purchase, build or improve a qualified home. A qualified home can be a main home or a second home that you at least partially own. The mortgage can be a first mortgage, second mortgage or a home equity loan that is secured by the home. The total of these mortgages must be no more that $1 million -- or $500,000 if you're married and filing separately.
Home Equity Loans
If a home equity loan is not used to purchase, build or improve a home, the interest may still be deductible. The home equity loan must be no more than $100,000 -- or $50,000 if you're married and filing separately. In addition, the combined total of mortgages and the home equity loan must be less than the fair market value of the secured home for the equity interest to be fully deductible. Internal Revenue Service Publication 936 can help you determine what portion of mortgage interest is deductible for loans that are not within these limits.
Other Mortgage Interest Deductions
Private mortgage insurance is generally required when less than 20 percent of the purchase price is paid as a down payment toward the purchase of a home. PMI payments are deductible along with mortgage interest. Points paid when a mortgage is taken out are also deductible as mortgage interest. If you pay off your mortgage early, your lender may charge a prepayment penalty. That penalty may also be deducted as mortgage interest in the year it was paid. This information will be reported to you on Form 1098.
Only one home can be treated as a second home for tax purposes in a particular year. If you rent out your second home for the entire year, that home cannot be treated as a second home. You must use the rented home at least part of the year to consider it a second home. However, if you have a second home that you do not make available for rent during the year, you do not have to personally use that home during the year for it to be considered a second home. Under these rules, your interest in a time share can be considered a second home.