Taxation

Deducting Student Loan & Mortgage Interest

In April, about the next best thing to a long-awaited spring day is a good tax deduction. Lowering the taxes you may owe can be just as satisfying as warm spring breeze.

Deducting the interest you pay on a student loan and a home mortgage can mean big tax savings. You have to follow the rules, though.

Student Loans

You can deduct all or some of the interest you pay on a school-related loan. As a general rule, you can deduct $2,500 or the full amount of interest you paid, whichever is less. And there's more good news: You don't have to itemize to get the deduction.

There are two main rules you need to follow:

1. The loan must be a qualified student loan, meaning it was:

  • Taken out only to pay for qualified education expenses, such as tuition, fees, books and room and board (there's a limit on room and board)
  • For you, your spouse, or your dependent (usually your child or qualifying relative)
  • Used for the education of eligible student - one enrolled least half-time in a program that leads to a degree or certificate
  • Not a loan from someone related to you ( a parent, spouse sibling, for example) or not from a qualified employer plan

2. You qualify for the credit only if:

  • You paid interest in tax year 2010. If you didn't make any payments, such as during a forbearance, there's no deduction
  • You're legally obligated to pay the interest - you either took out the loan or co-signed the loan. A friend or relative who didn't co-sign the loan can't take the deduction even if he pays interest
  • You don't use the married filing separately filing status
  • Your 2010 modified adjusted gross income (MAGI) is less than $75,000 ($150,000 if filing a joint return)
  • You (and your spouse, if filing jointly) can't be claimed as dependents on someone else's tax return

If you paid $600 or more of interest on a qualified student loan during the year, you should get a Form 1098-E from the lender or loan servicer. If you don't get the form, call and ask for one.

If you have any questions about deducting student loan interest, the IRS has a helpful booklet loaded with details, instructions and examples.

Mortgage Interest

You can also deduct all or some of the interest you pay on your home mortgage - a loan that's secured your main home or a second home. The IRS rules can complicated, but here how it works in general.

You can only take the deduction if you itemized deductions. Also, the mortgage must be:

  • A secured debt - meaning your house is collateral. In other words, if you don't repay the loan, the bank can take your home as payment (or foreclose)
  • On a qualified home. This is your main home or a second home, so long as it has sleeping, cooking and toilet facilities

How Much?

You can deduct all mortgage interest you paid in 2010 if the loan was taken out

  • On or before October 13, 1987. This is called grandfathered debt
  • After October 13, 1987, to buy, build, or improve your home, but only if throughout 2010 the mortgages plus any grandfathered debt was $1 million or less ($500,000 or less if married filing separately)
  • After October 13, 1987, other than to buy, build, or improve your home (called home equity debt), but only if throughout 2010 the mortgage totaled $100,000 or less ($50,000 or less if married filing separately) and totaled no more than the fair market value of your home reduced by the first two items above

If your mortgage doesn't fall into one of these categories, your deduction is limited and other IRS rules apply.

Points

If you paid points - additional charges to get a mortgage or to get a special interest rate - they may or may not be deductible in full in the year you pay them. As general rules, if:

  • You can deduct all of the interest on your mortgage, you may be able to deduct all of the points paid on the mortgage
  • If your purchase-money or acquisition debt on the home mortgage is more than $1 million or your home equity debt is more than $1,000,000, you can't deduct all of your points

If you can't take a full deduction, you treat the points as prepaid interest and take partial deductions each year over the life of the mortgage.

If you have questions about deducting points, be sure to read through the IRS pamphlet for more details and instructions.

These deductions can save you a lot of money if you do it right - or it may cost you money and headaches if you get it wrong. If you have any questions while preparing your return, talk to a professional tax preparer or a tax lawyer before you file.

Questions for Your Attorney

  • If I can't deduct all of my student loan interest this year, can I use the leftover portion next year as a deduction?
  • I didn't deduct mortgage interest on last year's taxes. Can I claim that interest on this year's tax return?
  • If I sell my home and I pay points so my buyer can get a mortgage, can I deduct the points on my tax return?
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