When you purchase a home, you're not only paying the purchase price of the home but also the interest that is tacked on to your monthly payment. In fact, if you take out a traditional, 30-year fixed-rate mortgage and keep the home and the loan for the duration, you'll likely end up paying more in interest than you paid for the home's actual purchase price. Fortunately, that mortgage interest may be deductible for some taxpayers.
Tax Deductible Interest
Home mortgage loan interest can be tax deductible, meaning that you can use interest you pay on your mortgage as a means to lower your tax burden. This is especially beneficial to you in the early years of your mortgage when most of your monthly payment goes toward paying the interest instead of the principal.
In order to be able deduct your mortgage interest, your mortgage must qualify as secured debt. According to the IRS, your mortgage is considered as secured debt if your ownership in the home is viewed as security for payment of the loan, your home could be used to satisfy the debt in the event of your default and your mortgage agreement is recorded under any applicable state law. If your mortgage meets these conditions, you will likely be able to deduct all the mortgage interest you pay.
You don't have to be a tax whiz or accounting expert to know how much mortgage interest you've paid. Each year, your mortgage company will send you a Form 1098 which will show your exact amount of interest you've paid during the year. To take advantage of the deduction, you will need to complete your taxes using IRS Form 1040 so you can itemize your deductions. Of course, you should also calculate your taxes with the standard deduction by using Form 1040A to determine which method will result in greater tax savings.
A situation where mortgage interest could be considered as taxable income is in the case of a seller-financed mortgage transaction. This occurs when you, as the owner of a house, extend financing to a buyer on your own to facilitate the sale of your home. You would need to report interest you earn from this type of transaction as taxable income as long as the buyer used the home as a residence during the tax year.