Homeowners’ biggest deductions: mortgage interest, property tax

SUE McALLISTER
San Jose Mercury News

Owning a home means different things to different people – but all homeowners share one thing in common: an appreciation for the tax breaks they get.

There can be numerous tax benefits to owning a home, the most important being the deduction of real estate taxes and mortgage interest from your taxable income.

If you bought a home last year, the "settlement documents" you received when you closed on your house – also known as a HUD-1 statement – should show how much property tax you paid at that time.

If you paid taxes to your county tax collector during 2004, you should have your own records of those payments.

Note to new homeowners: Hold on to your closing documents. They will help you calculate your taxes when you sell the home.

If you bought a home in 2004, you can also deduct the full cost of any "points" you paid when you got your mortgage, in most cases. A point is equal to 1 percent of the mortgage amount and is usually paid up front in exchange for a lower rate on the loan. Your closing documents will show how much you paid in points.

If you refinanced a mortgage in 2004, however, you must deduct any points you paid for the new loan gradually over the term of the loan. If you refinance again, you can deduct any remaining balance of points at that time, unless you refinance the mortgage with the same lender. If you do that, you’ll deduct the remaining balance over the life of the new loan.

Most homeowners will also be able to deduct the amount they paid in mortgage interest last year. But there are exceptions, so you may want to consult a professional tax preparer, or read IRS Publication 936 on "Home Mortgage Interest Deduction" to ensure your interest payments can legally be deducted.

In general, if your mortgage(s) fit into one of the following categories, you can deduct all the interest you paid:

• Mortgages taken out on or before Oct. 13, 1987, called "grandfathered" debt.
• Mortgages taken out after the above date and used to buy, build or improve your home, provided that these mortgages and any grandfathered debt equaled $1 million or less.
• Mortgages taken out after the above date that were used for something other than buying, building or improving your home, provided these mortgages equaled $100,000 or less, and all the mortgages on the home equaled no more than the home’s fair market value.

Claudia Hill, owner of Tax Mam Tax Services Group in Cupertino, Calif., said many homeowners don’t realize there is a limit on how much interest they can deduct if they used the proceeds of a home equity loan to pay college tuition or credit-card debt, for example.

By Jan. 31, your mortgage lender should have sent you a statement showing the total interest you paid in 2004. If you purchased your main home last year, it will also show deductible points paid during the year.

If you have a second home, you usually can deduct the full amount you paid in mortgage interest for that home, too, provided that your total mortgage debt doesn’t exceed $1 million.

If you rent out your second home, there are some exceptions to this. See Publication 936 for details or consult a tax preparer.