The IRS usually doesn't care who your lender is. If you own a house and have a loan on it that meets the IRS's definition of a mortgage, you should be able to deduct your interest. If you're the owner doing the financing, you can also write off the interest that you pay on the house, although the process is different.
IRS Mortgage Rules
To be able to deduct your mortgage, the IRS requires that it be a secured debt placed against what the IRS considers to be a qualified home. Your first or second home can both be qualified homes. To be considered homes, they have to have a place to sleep, a place to cook and a place to go to the bathroom. This means that a trailer or boat can qualify. Secured debts are any types of financing where the lender can take the house if you don't pay. Mortgages, trust deeds or land contracts -- also known as contracts for deed or installment sales -- qualify. Rent-to-own arrangements don't qualify because you don't own the house. The interest from a boat that you bought on a credit card doesn't qualify, either, since credit cards are usually unsecured. You don't have to spend every day -- or even a majority of the days in the year -- for a home's mortgage interest to be deductible.
Writing Off Interest
To write off the interest that you pay, you will need to itemize your deductions by attaching a complete Schedule A to your 1040 tax return. This means that you won't be able to claim the standard deduction, so you might want to make sure that all of your itemized deductions add up to more than your standard deduction. Assuming that you qualify, you can write off the interest on your first $1 million in house debt -- owner or bank-financed -- on line 10 or line 11 of your Schedule A.
Special Owner Financing Concerns
With a traditional bank lender or mortgage company, you will get a Form 1098 after the end of the year that lists how much you paid in interest so that you can enter it on line 10 of Schedule A. When an owner finances you, though, you might not get one. Instead, you will have to fill in the amount that you paid in interest on line 11 of Schedule A. In addition, the IRS requires you to write in the name, address and taxpayer identification number of the person to whom you pay the interest next to line 11. That way, the IRS can make sure that the owner is reporting her income.
When Owners Are Lenders
If you sell your house and let the buyer finance his purchase through you, it can complicate your taxes. The IRS requires you to report the interest you receive from the buyer on the Schedule B form where you list your interest and dividend income. If you receive principal payments, Form 6252 splits them into a return of your purchase price and a capital gain, which you might have to report on Schedule D. If you have an existing mortgage that you're paying with the new buyer's payments, you can deduct the interest that you pay to that lender as investment interest on your Schedule A form. Since you are selling the home to someone else, however -- and he can deduct the interest he pays to you -- it isn't a qualified home for your mortgage interest deduction any more.
Steve Lander has been a writer since 1996, with experience in the fields of financial services, real estate and technology. His work has appeared in trade publications such as the "Minnesota Real Estate Journal" and "Minnesota Multi-Housing Association Advocate." Lander holds a Bachelor of Arts in political science from Columbia University.