Interest paid on a mortgage is tax-deductible. All interest payments you make during the tax year are deductible on that year's taxes, even if you suffered a foreclosure on your home at some point during the year. Payments you made up to the day of the foreclosure are deductible on your income taxes. Should you make mortgage payments while your home is in the foreclosure process, this interest is also deductible when you file your income tax. All mortgage interest you paid to the lender should appear on the IRS Form 1098 that the lender sends you at year's end.
The portion of your mortgage payments applied to interest is tax-deductible in the year you made these payments. For example, if your home is foreclosed upon in September, any interest you paid as part of your mortgage payments before the foreclosure date is deductible -- that is, until you no longer own the house.
When your mortgage payments are not made on time and as agreed, your mortgage loan becomes delinquent. Depending on the language in your mortgage loan note, at some point your loan falls into a "default" condition -- sometimes if even one payment is not made on time. Once your loan is in default, your mortgage lender is allowed to start foreclosure proceedings. Your local state rules or specific loan note language specifies the conditions that constitute default and permit foreclosure actions.
Regardless of the amount of interest due, you can only deduct the amount of interest you've actually paid. As an individual taxpayer, you cannot "accrue" interest expenses -- that is, you cannot record them as if they were actually paid. Only the interest you've paid -- and your lender received -- is deductible. For example, you could owe more than $10,000 in delinquent interest, but only the interest you have actually paid is deductible on your next income tax filing.
IRS Form 1098
Your mortgage lender must send you an IRS Form 1098 by January 31 of the new year, displaying all of the mortgage interest you paid in the prior year. Until a foreclosure is complete and you no longer own the home, all interest you pay should appear on this form. Your lender sends the IRS the original copy of this form showing the mortgage interest you paid during the prior year.