Owning a house is every American's dream. Hence the Government has given certain benefits to the people to own houses. One such thing is the deduction of tax from interest paid on mortgage loan taken for buying or building homes. This benefit can also be available for a second home or investment property. Substantial improvement of a house or building is also eligible for a tax deduction. Substantial improvement means increasing the value of the home/building, adding facilities for the new owner and prolonging the life of the house. It does not include the repairs that are needed due to wear and tear of the building such as repainting, plastering, wall papering etc.
There are two kinds of debt mortgages on houses. One is acquisition indebtedness and the other is equity indebtedness. Amount borrowed for buying, building or substantially improving one's home is called acquisition indebtedness whereas the amount borrowed on refinancing for any reason other than for home improvement is known as equity indebtedness.
The amount of interest that is eligible for tax deduction is up to a sum of $1 million of acquisition indebtedness. In addition, interest on an amount of $100,000 on account of home equity debt is also deductible. This is available even if that sum was not utilized for home improvement. Real estate taxes and some of the property taxes are also eligible for tax deductions. The qualification is same for first hand as well as second homes and investment properties.
The amount of one million is not cumulative. If you pay off your debt, the amount paid off can be added to the purchasing of or improving up of two residences. With the fall in interest rates, the refinancing options are more favorable to the home owners, as the interest on such refinanced amount is also eligible for tax deduction.
The tax laws have changed after October 13th, 1987. There is a slight change in the amount deductible from tax. Any debt on account of refinancing before October 14th, 1987 is rolled into total acquisition indebtedness. There is a limit of $100,000 on equity debt and this amount is eligible for deduction irrespective of the fact that the amount is utilized for home improvement or not. The homeowners are allowed to cash in on some of the equity that has been built up in the home over time. This is called 2nd mortgage or junior lien. The upper limit is $100,000. For the eligibility of tax deduction, the primary, the second home or the investment property, must be pledged as collateral for the loan. The mortgage loan in excess of the value of the house is not eligible for deduction.