Post-1987 Loans

Loans that were taken out after October 13, 1987, will qualify for the mortgage interest deduction if they meet the criteria in either (A) or (B):

(A) Interest paid on mortgages used to buy, build, or substantially improve your first or second home is deductible (referred to as home acquisition debt), to the extent that the total of all these mortgages, plus any grandfathered debt, does not exceed the lower of:

• the total cost to buy or build the home, plus the cost of any improvements
• $1 million (for married taxpayers filing separately, this second limit is $500,000 each)

(B) Interest paid on mortgages used for any other purpose (commonly known as home equity debt) is deductible only to the extent that such mortgages totaled $100,000 or less throughout the year and totaled no more than the fair market value of your home reduced by any grandfathered or home acquisition debt. The limit is $50,000 each for married taxpayers filing separately. You can't deduct the interest, however, if you used the money to generate tax-exempt interest (e.g., if you bought tax-free municipal bonds).

It is important to keep in mind that, if the total amount of all loans secured by a home is more than the fair market value (FMV) of the home, you can't deduct interest on the portion of debt that exceeds the FMV. In recent years, some lenders in some areas of the country have been willing to extend loans that exceed 100 percent of the home's value; the interest on the excess portion of the debt is not deductible.

If you are married filing separately, who gets to deduct the interest? Generally, a taxpayer can deduct interest he or she pays on a mortgage if the taxpayer is the legal or equitable owner of the property. In the marital setting, ownership rights and their tax treatment when filing separately can get complicated. If a home is owned jointly, each spouse can deduct half the interest payments. If two houses are involved and the spouses are filing separately, each spouse can treat one houses as their qualified residence for interest deduction purposes unless both spouses agree in writing to a different arrangement.