Mortgage Interest: What Can You Deduct at Tax Time?

Let's take this example. In 2000, you bought a condominium for $300,000 and obtained a $240,000 loan. Based on the rapid appreciation in the years after you bought, your unit is now worth $500,000, even if it has lost value recently. You still owe $230,000. You refinance and get a new loan in the amount of $400,000. Your acquisition indebtedness is the amount you owed on your old loan, $230,000. Subject to the third limitation, discussed below, you can deduct the interest only on that amount.

If some of the money you borrow is used to "substantially improve" the home, that also can be counted as acquisition debt. So if you spend $20,000 from your refinancing on a major upgrade, that becomes deductible, for a total of $250,000 in acquisition indebtedness.

The third limitation involves home-equity loans. You can deduct interest on up to $100,000 of home equity mortgage indebtedness, on top of your acquisition debt. This applies whether you incur the debt via a home equity line of credit or a cash-out refinancing.

So, in our example, you can deduct the interest on $350,000 -- that is, $230,000 on the original acquisition debt, $20,000 added to that for your substantial improvement and $100,000 in home equity debt. The interest on the final $50,000 of the $400,000 you borrowed is not deductible.

For more details about these points and others involving mortgage interest, see IRS Publication 936, "Home Mortgage Interest Deduction," available at http://www.irs.gov. Here are some other things to keep in mind about interest deductibility:

· Cooperative housing. A qualified home can be a recreational vehicle or a boat, as long as it contains a kitchen, sleeping quarters and a toilet. But what about housing cooperatives, of which there any many in the Washington area?

According to the IRS, "A qualified home includes stock in a cooperative housing corporation owned by a tenant-stockholder. This applies only if the tenant-stockholder is entitled to live in the house or apartment because of owning stock in the cooperative."

The IRS suggests that to qualify for the interest deduction, the cooperative must have only one class of stock outstanding. However, especially in the District, there are a number of associations that do not have stock certificates but only documents called "proprietary leases." My informal discussions with IRS representatives have led me to believe that those co-ops count as qualified homes. However, co-op owners should consult with their financial and legal advisers on their specific situations.

Generally, if you are a co-op owner, you can deduct payments you make for your share of the interest paid by the cooperative, as well as any interest you pay for your individual share loan that you obtained when you bought your unit.

· Reverse mortgages. More people are obtaining reverse mortgages, either from commercial lenders or from their families. These loans -- generally available only to people 62 and older who have little or no current mortgage obligations -- provide cash to the homeowner in monthly annuities, a line of credit or a lump sum. Interest accrues until the homeowner sells the house or dies. This interest is not deductible until the loan is paid in full. It should be noted that the home acquisition debt limits discussed above apply to reverse mortgages, and your tax accountant should be consulted to determine exactly how much interest will be tax-deductible.