When you finance a home, the loan is secured with a mortgage or deed of trust. The type of instrument used depends on the state. You're also required to sign a promissory note, which is your promise to repay the loan. A mortgage or deed of trust is not recorded in public records. Instead, the lender holds onto the note as proof of the agreement. Promissory notes are also used in seller or owner-financing purchases. You don't need to notify the Internal Revenue Service if you're making note payments towards real property.
The IRS doesn't require you to report your mortgage or loan obligation on your income tax return. Even if you choose to claim deductions as a homeowner, you aren't required to report the details of your mortgage. The IRS only wants to know about your income and assets that produce taxable interest. Your living arrangements are not important to the IRS, unless they produce income. For example, a landlord must report income he receives on a rental property he owns.
You can deduct the interest you paid on the loan for the year. If you paid more than $600, the lender is required to issue a 1098 Mortgage Interest Statement. The IRS sets forth the eligibility requirements for claiming the deduction. You'll qualify for the deduction if you were legally obligated to make the payments and actually made the payments. If a friend or family member paid your mortgage for a couple of months, you can't claim the interest for those months. Loan origination fees and points paid are also qualifying deductions for homeowners.
Seller Financing Deductions
If the seller is acting as the lender, you may still qualify for the deduction, depending on the type of agreement. Although a promissory note is legally binding, it isn't necessarily enough to meet the IRS guidelines for the interest deduction. In addition to being legally obligated to make the payments, you must have ownership interest in the home. A land contract is a form of seller-financing that qualifies for the interest deduction because the title is recorded in the buyer's name. If the lender's name stays on the deed until the debt is paid, you can't claim the interest deduction.
Although the IRS doesn't need to know you are making loan payments, the loan debt may be relevant under certain circumstances. If you are selected for an audit, you will need to disclose financial information, including your bank statements. You'll need to explain your expenses, especially lump sums of money coming out of your bank account. When you sell the home, you'll need to report the gain on your taxes if the property isn't your primary residence.
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