While almost every taxpayer has a loan on which he pays deductible interest, there are also lesser known interest deductions for "loan fees," "prepayment penalties," "discounts," and "ground rent."

The itemized tax deduction for interest is a subsidy by Uncle Sam to the borrower. As a result, after considering income tax dollars saved, interest doesn't really cost the borrower the full amount of interest which the lender collects.

For example, suppose you borrow on a new home mortgage at the seemingly outrageously high interest rate of 13 percent. To compute your after-tax interest rate, multiply your income tax bracket by the loan's interest rate.

In this example 30 percent of 13 percent is 3.9 percent. This is the tax subsidy for the interest deduction. Subtracting 3.9 percent from 13 percent gives an after-tax borrowing cost of about 9.1 percent.

There are five principal types of tax deductions for interest paid in connection with real estate ownership.

(1) Loan interest. The most common type of interest deduction is for interest paid on borrowed money. The security device used, such as a mortgage, trust deed, land contact, or unsecured promissory note is irrelevant. m

Interest is tax deductible by the borrower as it is earned by the lender. Prepaid interest deductions for early interest payments are no longer allowed by federal tax laws.

(2) Loan fees. Most real estate lenders, such as banks, savings associations, and mortgage bankers, charge loan fees for granting real estate loans. These loan fees are fully tax deductible as interest in the year paid if the security for the loan is the borrower's personal residence.

But if the loan is paid to get a loan on any type of property, such as land or a commercial building, then the loan fee must be amortized (deducted) over the life of the loan. For example, if you pay a $1,000 loan fee to get a 30-year mortgage on property other than your personal residence, you can only deduct $33.33 each year for the 30 year term.

However, loan fees paid to get a VA or FHA home loan are not deductible as interest. The IRS says the buyer's "loan processing fee" is not interest but a non-deductible service charge. The VA or FHA loan fee, paid by the property's seller, is similarly not tax deductible as interest since the seller doesn't owe money on the loan. But such VA or FHA loan fees can be subtracted by the seller as a sales expense from the gross sales price of the home.

(3) Ground rent. Many homes and commercial buildings are constructed on leased land. If the lease is for at least 15 years and if the tenant has an option to buy the land, Internal Revenue Code section 1055 permits deduction of the ground rent as interest. The IRS views such rent as being like deductible mortgages interest. But if there is no purchase option, the ground rent is not tax deductible.

(4) Loan discounts. Many loans, such as home improvement loans, are discounted. That means interest is paid to the lender at the time of the borrowing. Such interest is deductible equally over the life of the loan, rather than all in the year the loan was obtained.

(5) Prepayment penalties. If a lender charges a prepayment penalty for early payoff of a loan, this fee is tax deductible as interest. Further details should be obtained from your tax advisor.

Owners who sold houses last year may believe that money spent fixing up a house to get it ready for sale is tax deductible. But this is not correct.

The truth is that costs of getting a home fixed up for sale -- costs for such things as painting and repairing -- will save tax dollars only if the home seller is buying a less expensive replacement home. Any other circumstance won't result in a tax savings.

Internal Revenue Code section 1034B says cost of fixing up your principal residence to prepare it for sale are subtractions (not deductions) from its gross sales price if (a) contracted for within 90 days before the contract is signed and (b) paid for within 30 days after the sale closing.

These fix-up costs are defined as household expenses that normally have no tax significance, such as costs for cleaning, painting and repairing, since they are personal living expenses. Major household expenditures, such as for a new roof, new furnance or replumbing, are not fix-up costs but capital improvements that should be added to the owner's cost basis for the house.

Qualified home sale fix-up expenses result in tax deferral, not tax exemptions. Eventually the tax must be paid. The fix-up sale rule only delays the eventual tax payment in cheaper, inflated dollars.

To understand this home sale fix-up rule, the "residence replacement rule" must first be understood. The rule has two parts. One says that a taxpayer who sells a principal residence and buys another of equal or greater value within 18 months before or after the sale must defer paying the profit tax until the replacement is sold without buying another house.

The other part of the rule says that if a less expensive replacement principal residence is bought within 18 months before or after the sale, the seller's profit is taxable up to the difference in the two prices.

Since the profit tax is deferred when a more costly replacement is bought, the home sale fix-up rule won't save any taxes since the residence replacement rule already requires tax deferral in that situation. So the only circumstance when tax will be saved, by tax deferral, is when the home seller buys a less expensive replacement residence.