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Myfreetaxes org 13. Myfreetaxes org   Basis of Property Table of Contents Introduction Useful Items - You may want to see: Cost BasisReal Property Adjusted BasisIncreases to Basis Decreases to Basis Basis Other Than CostProperty Received for Services Taxable Exchanges Involuntary Conversions Nontaxable Exchanges Property Transferred From a Spouse Property Received as a Gift Inherited Property Property Changed From Personal to Business or Rental Use Stocks and Bonds Introduction This chapter discusses how to figure your basis in property. Myfreetaxes org It is divided into the following sections. Myfreetaxes org Cost basis. Myfreetaxes org Adjusted basis. Myfreetaxes org Basis other than cost. Myfreetaxes org Your basis is the amount of your investment in property for tax purposes. Myfreetaxes org Use the basis to figure gain or loss on the sale, exchange, or other disposition of property. Myfreetaxes org Also use it to figure deductions for depreciation, amortization, depletion, and casualty losses. Myfreetaxes org If you use property for both business or investment purposes and for personal purposes, you must allocate the basis based on the use. Myfreetaxes org Only the basis allocated to the business or investment use of the property can be depreciated. Myfreetaxes org Your original basis in property is adjusted (increased or decreased) by certain events. Myfreetaxes org For example, if you make improvements to the property, increase your basis. Myfreetaxes org If you take deductions for depreciation or casualty losses, or claim certain credits, reduce your basis. Myfreetaxes org Keep accurate records of all items that affect the basis of your property. Myfreetaxes org For more information on keeping records, see chapter 1. Myfreetaxes org Useful Items - You may want to see: Publication 15-B Employer's Tax Guide to Fringe Benefits 525 Taxable and Nontaxable Income 535 Business Expenses 537 Installment Sales 544 Sales and Other Dispositions of Assets 550 Investment Income and Expenses 551 Basis of Assets 946 How To Depreciate Property Cost Basis The basis of property you buy is usually its cost. Myfreetaxes org The cost is the amount you pay in cash, debt obligations, other property, or services. Myfreetaxes org Your cost also includes amounts you pay for the following items: Sales tax, Freight, Installation and testing, Excise taxes, Legal and accounting fees (when they must be capitalized), Revenue stamps, Recording fees, and Real estate taxes (if you assume liability for the seller). Myfreetaxes org In addition, the basis of real estate and business assets may include other items. Myfreetaxes org Loans with low or no interest. Myfreetaxes org    If you buy property on a time-payment plan that charges little or no interest, the basis of your property is your stated purchase price minus any amount considered to be unstated interest. Myfreetaxes org You generally have unstated interest if your interest rate is less than the applicable federal rate. Myfreetaxes org   For more information, see Unstated Interest and Original Issue Discount (OID) in Publication 537. Myfreetaxes org Real Property Real property, also called real estate, is land and generally anything built on, growing on, or attached to land. Myfreetaxes org If you buy real property, certain fees and other expenses you pay are part of your cost basis in the property. Myfreetaxes org Lump sum purchase. Myfreetaxes org   If you buy buildings and the land on which they stand for a lump sum, allocate the cost basis among the land and the buildings. Myfreetaxes org Allocate the cost basis according to the respective fair market values (FMVs) of the land and buildings at the time of purchase. Myfreetaxes org Figure the basis of each asset by multiplying the lump sum by a fraction. Myfreetaxes org The numerator is the FMV of that asset and the denominator is the FMV of the whole property at the time of purchase. Myfreetaxes org    If you are not certain of the FMVs of the land and buildings, you can allocate the basis according to their assessed values for real estate tax purposes. Myfreetaxes org Fair market value (FMV). Myfreetaxes org   FMV is the price at which the property would change hands between a willing buyer and a willing seller, neither having to buy or sell, and both having reasonable knowledge of all the necessary facts. Myfreetaxes org Sales of similar property on or about the same date may be helpful in figuring the FMV of the property. Myfreetaxes org Assumption of mortgage. Myfreetaxes org   If you buy property and assume (or buy the property subject to) an existing mortgage on the property, your basis includes the amount you pay for the property plus the amount to be paid on the mortgage. Myfreetaxes org Settlement costs. Myfreetaxes org   Your basis includes the settlement fees and closing costs you paid for buying the property. Myfreetaxes org (A fee for buying property is a cost that must be paid even if you buy the property for cash. Myfreetaxes org ) Do not include fees and costs for getting a loan on the property in your basis. Myfreetaxes org   The following are some of the settlement fees or closing costs you can include in the basis of your property. Myfreetaxes org Abstract fees (abstract of title fees). Myfreetaxes org Charges for installing utility services. Myfreetaxes org Legal fees (including fees for the title search and preparation of the sales contract and deed). Myfreetaxes org Recording fees. Myfreetaxes org Survey fees. Myfreetaxes org Transfer taxes. Myfreetaxes org Owner's title insurance. Myfreetaxes org Any amounts the seller owes that you agree to pay, such as back taxes or interest, recording or mortgage fees, charges for improvements or repairs, and sales commissions. Myfreetaxes org   Settlement costs do not include amounts placed in escrow for the future payment of items such as taxes and insurance. Myfreetaxes org   The following are some of the settlement fees and closing costs you cannot include in the basis of property. Myfreetaxes org Casualty insurance premiums. Myfreetaxes org Rent for occupancy of the property before closing. Myfreetaxes org Charges for utilities or other services related to occupancy of the property before closing. Myfreetaxes org Charges connected with getting a loan, such as points (discount points, loan origination fees), mortgage insurance premiums, loan assumption fees, cost of a credit report, and fees for an appraisal required by a lender. Myfreetaxes org Fees for refinancing a mortgage. Myfreetaxes org Real estate taxes. Myfreetaxes org   If you pay real estate taxes the seller owed on real property you bought, and the seller did not reimburse you, treat those taxes as part of your basis. Myfreetaxes org You cannot deduct them as an expense. Myfreetaxes org    If you reimburse the seller for taxes the seller paid for you, you can usually deduct that amount as an expense in the year of purchase. Myfreetaxes org Do not include that amount in the basis of your property. Myfreetaxes org If you did not reimburse the seller, you must reduce your basis by the amount of those taxes. Myfreetaxes org Points. Myfreetaxes org   If you pay points to get a loan (including a mortgage, second mortgage, line of credit, or a home equity loan), do not add the points to the basis of the related property. Myfreetaxes org Generally, you deduct the points over the term of the loan. Myfreetaxes org For more information on how to deduct points, see chapter 23. Myfreetaxes org Points on home mortgage. Myfreetaxes org   Special rules may apply to points you and the seller pay when you get a mortgage to buy your main home. Myfreetaxes org If certain requirements are met, you can deduct the points in full for the year in which they are paid. Myfreetaxes org Reduce the basis of your home by any seller-paid points. Myfreetaxes org Adjusted Basis Before figuring gain or loss on a sale, exchange, or other disposition of property or figuring allowable depreciation, depletion, or amortization, you must usually make certain adjustments (increases and decreases) to the cost basis or basis other than cost (discussed later) of the property. Myfreetaxes org The result is the adjusted basis. Myfreetaxes org Increases to Basis Increase the basis of any property by all items properly added to a capital account. Myfreetaxes org Examples of items that increase basis are shown in Table 13-1. Myfreetaxes org These include the items discussed below. Myfreetaxes org Improvements. Myfreetaxes org   Add to your basis in property the cost of improvements having a useful life of more than 1 year, that increase the value of the property, lengthen its life, or adapt it to a different use. Myfreetaxes org For example, improvements include putting a recreation room in your unfinished basement, adding another bathroom or bedroom, putting up a fence, putting in new plumbing or wiring, installing a new roof, or paving your driveway. Myfreetaxes org Assessments for local improvements. Myfreetaxes org   Add to the basis of property assessments for improvements such as streets and sidewalks if they increase the value of the property assessed. Myfreetaxes org Do not deduct them as taxes. Myfreetaxes org However, you can deduct as taxes assessments for maintenance or repairs, or for meeting interest charges related to the improvements. Myfreetaxes org Example. Myfreetaxes org Your city changes the street in front of your store into an enclosed pedestrian mall and assesses you and other affected property owners for the cost of the conversion. Myfreetaxes org Add the assessment to your property's basis. Myfreetaxes org In this example, the assessment is a depreciable asset. Myfreetaxes org Decreases to Basis Decrease the basis of any property by all items that represent a return of capital for the period during which you held the property. Myfreetaxes org Examples of items that decrease basis are shown in Table 13-1. Myfreetaxes org These include the items discussed below. Myfreetaxes org Table 13-1. Myfreetaxes org Examples of Adjustments to Basis Increases to Basis Decreases to Basis • Capital improvements: • Exclusion from income of   Putting an addition on your home subsidies for energy conservation   Replacing an entire roof measures   Paving your driveway     Installing central air conditioning • Casualty or theft loss deductions   Rewiring your home and insurance reimbursements       • Assessments for local improvements:     Water connections     Extending utility service lines to the property • Postponed gain from the sale of a home   Sidewalks • Alternative motor vehicle credit  (Form 8910)   Roads       • Alternative fuel vehicle refueling     property credit (Form 8911)           • Residential energy credits (Form 5695)       • Casualty losses: • Depreciation and section 179 deduction   Restoring damaged property     • Nontaxable corporate distributions • Legal fees:     Cost of defending and perfecting a title • Certain canceled debt excluded from   Fees for getting a reduction of an assessment income     • Zoning costs • Easements           • Adoption tax benefits Casualty and theft losses. Myfreetaxes org   If you have a casualty or theft loss, decrease the basis in your property by any insurance proceeds or other reimbursement and by any deductible loss not covered by insurance. Myfreetaxes org    You must increase your basis in the property by the amount you spend on repairs that restore the property to its pre-casualty condition. Myfreetaxes org   For more information on casualty and theft losses, see chapter 25. Myfreetaxes org Depreciation and section 179 deduction. Myfreetaxes org   Decrease the basis of your qualifying business property by any section 179 deduction you take and the depreciation you deducted, or could have deducted (including any special depreciation allowance), on your tax returns under the method of depreciation you selected. Myfreetaxes org   For more information about depreciation and the section 179 deduction, see Publication 946 and the Instructions for Form 4562. Myfreetaxes org Example. Myfreetaxes org You owned a duplex used as rental property that cost you $40,000, of which $35,000 was allocated to the building and $5,000 to the land. Myfreetaxes org You added an improvement to the duplex that cost $10,000. Myfreetaxes org In February last year, the duplex was damaged by fire. Myfreetaxes org Up to that time, you had been allowed depreciation of $23,000. Myfreetaxes org You sold some salvaged material for $1,300 and collected $19,700 from your insurance company. Myfreetaxes org You deducted a casualty loss of $1,000 on your income tax return for last year. Myfreetaxes org You spent $19,000 of the insurance proceeds for restoration of the duplex, which was completed this year. Myfreetaxes org You must use the duplex's adjusted basis after the restoration to determine depreciation for the rest of the property's recovery period. Myfreetaxes org Figure the adjusted basis of the duplex as follows: Original cost of duplex $35,000 Addition to duplex 10,000 Total cost of duplex $45,000 Minus: Depreciation 23,000 Adjusted basis before casualty $22,000 Minus: Insurance proceeds $19,700     Deducted casualty loss 1,000     Salvage proceeds 1,300 22,000 Adjusted basis after casualty $-0- Add: Cost of restoring duplex 19,000 Adjusted basis after restoration $19,000 Note. Myfreetaxes org Your basis in the land is its original cost of $5,000. Myfreetaxes org Easements. Myfreetaxes org   The amount you receive for granting an easement is generally considered to be proceeds from the sale of an interest in real property. Myfreetaxes org It reduces the basis of the affected part of the property. Myfreetaxes org If the amount received is more than the basis of the part of the property affected by the easement, reduce your basis in that part to zero and treat the excess as a recognized gain. Myfreetaxes org   If the gain is on a capital asset, see chapter 16 for information about how to report it. Myfreetaxes org If the gain is on property used in a trade or business, see Publication 544 for information about how to report it. Myfreetaxes org Exclusion of subsidies for energy conservation measures. Myfreetaxes org   You can exclude from gross income any subsidy you received from a public utility company for the purchase or installation of an energy conservation measure for a dwelling unit. Myfreetaxes org Reduce the basis of the property for which you received the subsidy by the excluded amount. Myfreetaxes org For more information about this subsidy, see chapter 12. Myfreetaxes org Postponed gain from sale of home. Myfreetaxes org    If you postponed gain from the sale of your main home under rules in effect before May 7, 1997, you must reduce the basis of the home you acquired as a replacement by the amount of the postponed gain. Myfreetaxes org For more information on the rules for the sale of a home, see chapter 15. Myfreetaxes org Basis Other Than Cost There are many times when you cannot use cost as basis. Myfreetaxes org In these cases, the fair market value or the adjusted basis of the property can be used. Myfreetaxes org Fair market value (FMV) and adjusted basis were discussed earlier. Myfreetaxes org Property Received for Services If you receive property for your services, include the FMV of the property in income. Myfreetaxes org The amount you include in income becomes your basis. Myfreetaxes org If the services were performed for a price agreed on beforehand, it will be accepted as the FMV of the property if there is no evidence to the contrary. Myfreetaxes org Restricted property. Myfreetaxes org   If you receive property for your services and the property is subject to certain restrictions, your basis in the property is its FMV when it becomes substantially vested. Myfreetaxes org However, this rule does not apply if you make an election to include in income the FMV of the property at the time it is transferred to you, less any amount you paid for it. Myfreetaxes org Property is substantially vested when it is transferable or when it is not subject to a substantial risk of forfeiture (you do not have a good chance of losing it). Myfreetaxes org For more information, see Restricted Property in Publication 525. Myfreetaxes org Bargain purchases. Myfreetaxes org   A bargain purchase is a purchase of an item for less than its FMV. Myfreetaxes org If, as compensation for services, you buy goods or other property at less than FMV, include the difference between the purchase price and the property's FMV in your income. Myfreetaxes org Your basis in the property is its FMV (your purchase price plus the amount you include in income). Myfreetaxes org   If the difference between your purchase price and the FMV is a qualified employee discount, do not include the difference in income. Myfreetaxes org However, your basis in the property is still its FMV. Myfreetaxes org See Employee Discounts in Publication 15-B. Myfreetaxes org Taxable Exchanges A taxable exchange is one in which the gain is taxable or the loss is deductible. Myfreetaxes org A taxable gain or deductible loss also is known as a recognized gain or loss. Myfreetaxes org If you receive property in exchange for other property in a taxable exchange, the basis of the property you receive is usually its FMV at the time of the exchange. Myfreetaxes org Involuntary Conversions If you receive replacement property as a result of an involuntary conversion, such as a casualty, theft, or condemnation, figure the basis of the replacement property using the basis of the converted property. Myfreetaxes org Similar or related property. Myfreetaxes org   If you receive replacement property similar or related in service or use to the converted property, the replacement property's basis is the same as the converted property's basis on the date of the conversion, with the following adjustments. Myfreetaxes org Decrease the basis by the following. Myfreetaxes org Any loss you recognize on the involuntary conversion. Myfreetaxes org Any money you receive that you do not spend on similar property. Myfreetaxes org Increase the basis by the following. Myfreetaxes org Any gain you recognize on the involuntary conversion. Myfreetaxes org Any cost of acquiring the replacement property. Myfreetaxes org Money or property not similar or related. Myfreetaxes org    If you receive money or property not similar or related in service or use to the converted property, and you buy replacement property similar or related in service or use to the converted property, the basis of the replacement property is its cost decreased by the gain not recognized on the conversion. Myfreetaxes org Example. Myfreetaxes org The state condemned your property. Myfreetaxes org The adjusted basis of the property was $26,000 and the state paid you $31,000 for it. Myfreetaxes org You realized a gain of $5,000 ($31,000 − $26,000). Myfreetaxes org You bought replacement property similar in use to the converted property for $29,000. Myfreetaxes org You recognize a gain of $2,000 ($31,000 − $29,000), the unspent part of the payment from the state. Myfreetaxes org Your unrecognized gain is $3,000, the difference between the $5,000 realized gain and the $2,000 recognized gain. Myfreetaxes org The basis of the replacement property is figured as follows: Cost of replacement property $29,000 Minus: Gain not recognized 3,000 Basis of replacement property $26,000 Allocating the basis. Myfreetaxes org   If you buy more than one piece of replacement property, allocate your basis among the properties based on their respective costs. Myfreetaxes org Basis for depreciation. Myfreetaxes org   Special rules apply in determining and depreciating the basis of MACRS property acquired in an involuntary conversion. Myfreetaxes org For information, see What Is the Basis of Your Depreciable Property? in chapter 1 of Publication 946. Myfreetaxes org Nontaxable Exchanges A nontaxable exchange is an exchange in which you are not taxed on any gain and you cannot deduct any loss. Myfreetaxes org If you receive property in a nontaxable exchange, its basis is generally the same as the basis of the property you transferred. Myfreetaxes org See Nontaxable Trades in chapter 14. Myfreetaxes org Like-Kind Exchanges The exchange of property for the same kind of property is the most common type of nontaxable exchange. Myfreetaxes org To qualify as a like-kind exchange, the property traded and the property received must be both of the following. Myfreetaxes org Qualifying property. Myfreetaxes org Like-kind property. Myfreetaxes org The basis of the property you receive is generally the same as the adjusted basis of the property you gave up. Myfreetaxes org If you trade property in a like-kind exchange and also pay money, the basis of the property received is the adjusted basis of the property you gave up increased by the money you paid. Myfreetaxes org Qualifying property. Myfreetaxes org   In a like-kind exchange, you must hold for investment or for productive use in your trade or business both the property you give up and the property you receive. Myfreetaxes org Like-kind property. Myfreetaxes org   There must be an exchange of like-kind property. Myfreetaxes org Like-kind properties are properties of the same nature or character, even if they differ in grade or quality. Myfreetaxes org The exchange of real estate for real estate and personal property for similar personal property are exchanges of like-kind property. Myfreetaxes org Example. Myfreetaxes org You trade in an old truck used in your business with an adjusted basis of $1,700 for a new one costing $6,800. Myfreetaxes org The dealer allows you $2,000 on the old truck, and you pay $4,800. Myfreetaxes org This is a like-kind exchange. Myfreetaxes org The basis of the new truck is $6,500 (the adjusted basis of the old one, $1,700, plus the amount you paid, $4,800). Myfreetaxes org If you sell your old truck to a third party for $2,000 instead of trading it in and then buy a new one from the dealer, you have a taxable gain of $300 on the sale (the $2,000 sale price minus the $1,700 adjusted basis). Myfreetaxes org The basis of the new truck is the price you pay the dealer. Myfreetaxes org Partially nontaxable exchanges. Myfreetaxes org   A partially nontaxable exchange is an exchange in which you receive unlike property or money in addition to like-kind property. Myfreetaxes org The basis of the property you receive is the same as the adjusted basis of the property you gave up, with the following adjustments. Myfreetaxes org Decrease the basis by the following amounts. Myfreetaxes org Any money you receive. Myfreetaxes org Any loss you recognize on the exchange. Myfreetaxes org Increase the basis by the following amounts. Myfreetaxes org Any additional costs you incur. Myfreetaxes org Any gain you recognize on the exchange. Myfreetaxes org If the other party to the exchange assumes your liabilities, treat the debt assumption as money you received in the exchange. Myfreetaxes org Allocation of basis. Myfreetaxes org   If you receive like-kind and unlike properties in the exchange, allocate the basis first to the unlike property, other than money, up to its FMV on the date of the exchange. Myfreetaxes org The rest is the basis of the like-kind property. Myfreetaxes org More information. Myfreetaxes org   See Like-Kind Exchanges in chapter 1 of Publication 544 for more information. Myfreetaxes org Basis for depreciation. Myfreetaxes org   Special rules apply in determining and depreciating the basis of MACRS property acquired in a like-kind exchange. Myfreetaxes org For information, see What Is the Basis of Your Depreciable Property? in chapter 1 of Publication 946. Myfreetaxes org Property Transferred From a Spouse The basis of property transferred to you or transferred in trust for your benefit by your spouse is the same as your spouse's adjusted basis. Myfreetaxes org The same rule applies to a transfer by your former spouse that is incident to divorce. Myfreetaxes org However, for property transferred in trust, adjust your basis for any gain recognized by your spouse or former spouse if the liabilities assumed, plus the liabilities to which the property is subject, are more than the adjusted basis of the property transferred. Myfreetaxes org If the property transferred to you is a series E, series EE, or series I U. Myfreetaxes org S. Myfreetaxes org savings bond, the transferor must include in income the interest accrued to the date of transfer. Myfreetaxes org Your basis in the bond immediately after the transfer is equal to the transferor's basis increased by the interest income includible in the transferor's income. Myfreetaxes org For more information on these bonds, see chapter 7. Myfreetaxes org At the time of the transfer, the transferor must give you the records needed to determine the adjusted basis and holding period of the property as of the date of the transfer. Myfreetaxes org For more information about the transfer of property from a spouse, see chapter 14. Myfreetaxes org Property Received as a Gift To figure the basis of property you receive as a gift, you must know its adjusted basis to the donor just before it was given to you, its FMV at the time it was given to you, and any gift tax paid on it. Myfreetaxes org FMV less than donor's adjusted basis. Myfreetaxes org   If the FMV of the property at the time of the gift is less than the donor's adjusted basis, your basis depends on whether you have a gain or a loss when you dispose of the property. Myfreetaxes org Your basis for figuring gain is the same as the donor's adjusted basis plus or minus any required adjustments to basis while you held the property. Myfreetaxes org Your basis for figuring loss is its FMV when you received the gift plus or minus any required adjustments to basis while you held the property. Myfreetaxes org See Adjusted Basis , earlier. Myfreetaxes org Example. Myfreetaxes org You received an acre of land as a gift. Myfreetaxes org At the time of the gift, the land had an FMV of $8,000. Myfreetaxes org The donor's adjusted basis was $10,000. Myfreetaxes org After you received the property, no events occurred to increase or decrease your basis. Myfreetaxes org If you later sell the property for $12,000, you will have a $2,000 gain because you must use the donor's adjusted basis at the time of the gift ($10,000) as your basis to figure gain. Myfreetaxes org If you sell the property for $7,000, you will have a $1,000 loss because you must use the FMV at the time of the gift ($8,000) as your basis to figure loss. Myfreetaxes org If the sales price is between $8,000 and $10,000, you have neither gain nor loss. Myfreetaxes org Business property. Myfreetaxes org   If you hold the gift as business property, your basis for figuring any depreciation, depletion, or amortization deductions is the same as the donor's adjusted basis plus or minus any required adjustments to basis while you hold the property. Myfreetaxes org FMV equal to or greater than donor's adjusted basis. Myfreetaxes org   If the FMV of the property is equal to or greater than the donor's adjusted basis, your basis is the donor's adjusted basis at the time you received the gift. Myfreetaxes org Increase your basis by all or part of any gift tax paid, depending on the date of the gift, explained later. Myfreetaxes org   Also, for figuring gain or loss from a sale or other disposition or for figuring depreciation, depletion, or amortization deductions on business property, you must increase or decrease your basis (the donor's adjusted basis) by any required adjustments to basis while you held the property. Myfreetaxes org See Adjusted Basis , earlier. Myfreetaxes org   If you received a gift during the tax year, increase your basis in the gift (the donor's adjusted basis) by the part of the gift tax paid on it due to the net increase in value of the gift. Myfreetaxes org Figure the increase by multiplying the gift tax paid by a fraction. Myfreetaxes org The numerator of the fraction is the net increase in value of the gift and the denominator is the amount of the gift. Myfreetaxes org   The net increase in value of the gift is the FMV of the gift minus the donor's adjusted basis. Myfreetaxes org The amount of the gift is its value for gift tax purposes after reduction by any annual exclusion and marital or charitable deduction that applies to the gift. Myfreetaxes org Example. Myfreetaxes org In 2013, you received a gift of property from your mother that had an FMV of $50,000. Myfreetaxes org Her adjusted basis was $20,000. Myfreetaxes org The amount of the gift for gift tax purposes was $36,000 ($50,000 minus the $14,000 annual exclusion). Myfreetaxes org She paid a gift tax of $7,320 on the property. Myfreetaxes org Your basis is $26,076, figured as follows: Fair market value $50,000 Minus: Adjusted basis −20,000 Net increase in value $30,000     Gift tax paid $7,320 Multiplied by ($30,000 ÷ $36,000) × . Myfreetaxes org 83 Gift tax due to net increase in value $6,076 Adjusted basis of property to your mother +20,000 Your basis in the property $26,076 Note. Myfreetaxes org If you received a gift before 1977, your basis in the gift (the donor's adjusted basis) includes any gift tax paid on it. Myfreetaxes org However, your basis cannot exceed the FMV of the gift at the time it was given to you. Myfreetaxes org Inherited Property Your basis in property you inherited from a decedent, who died before January 1, 2010, or after December 31, 2010, is generally one of the following: The FMV of the property at the date of the decedent's death. Myfreetaxes org The FMV on the alternate valuation date if the personal representative for the estate elects to use alternate valuation. Myfreetaxes org The value under the special-use valuation method for real property used in farming or a closely held business if elected for estate tax purposes. Myfreetaxes org The decedent's adjusted basis in land to the extent of the value excluded from the decedent's taxable estate as a qualified conservation easement. Myfreetaxes org If a federal estate tax return does not have to be filed, your basis in the inherited property is its appraised value at the date of death for state inheritance or transmission taxes. Myfreetaxes org For more information, see the instructions to Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return. Myfreetaxes org Property inherited from a decedent who died in 2010. Myfreetaxes org   If you inherited property from a decedent who died in 2010, special rules may apply. Myfreetaxes org For more information, see Publication 4895, Tax Treatment of Property Acquired From a Decedent Dying in 2010. Myfreetaxes org Community property. Myfreetaxes org   In community property states (Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin), husband and wife are each usually considered to own half the community property. Myfreetaxes org When either spouse dies, the total value of the community property, even the part belonging to the surviving spouse, generally becomes the basis of the entire property. Myfreetaxes org For this rule to apply, at least half the value of the community property interest must be includible in the decedent's gross estate, whether or not the estate must file a return. Myfreetaxes org Example. Myfreetaxes org You and your spouse owned community property that had a basis of $80,000. Myfreetaxes org When your spouse died, half the FMV of the community interest was includible in your spouse's estate. Myfreetaxes org The FMV of the community interest was $100,000. Myfreetaxes org The basis of your half of the property after the death of your spouse is $50,000 (half of the $100,000 FMV). Myfreetaxes org The basis of the other half to your spouse's heirs is also $50,000. Myfreetaxes org For more information about community property, see Publication 555, Community Property. Myfreetaxes org Property Changed From Personal to Business or Rental Use If you hold property for personal use and then change it to business use or use it to produce rent, you can begin to depreciate the property at the time of the change. Myfreetaxes org To do so, you must figure its basis for depreciation at the time of the change. Myfreetaxes org An example of changing property held for personal use to business or rental use would be renting out your former personal residence. Myfreetaxes org Basis for depreciation. Myfreetaxes org   The basis for depreciation is the lesser of the following amounts. Myfreetaxes org The FMV of the property on the date of the change. Myfreetaxes org Your adjusted basis on the date of the change. Myfreetaxes org Example. Myfreetaxes org Several years ago, you paid $160,000 to have your house built on a lot that cost $25,000. Myfreetaxes org You paid $20,000 for permanent improvements to the house and claimed a $2,000 casualty loss deduction for damage to the house before changing the property to rental use last year. Myfreetaxes org Because land is not depreciable, you include only the cost of the house when figuring the basis for depreciation. Myfreetaxes org Your adjusted basis in the house when you changed its use was $178,000 ($160,000 + $20,000 − $2,000). Myfreetaxes org On the same date, your property had an FMV of $180,000, of which $15,000 was for the land and $165,000 was for the house. Myfreetaxes org The basis for figuring depreciation on the house is its FMV on the date of the change ($165,000) because it is less than your adjusted basis ($178,000). Myfreetaxes org Sale of property. Myfreetaxes org   If you later sell or dispose of property changed to business or rental use, the basis you use will depend on whether you are figuring gain or loss. Myfreetaxes org Gain. Myfreetaxes org   The basis for figuring a gain is your adjusted basis in the property when you sell the property. Myfreetaxes org Example. Myfreetaxes org Assume the same facts as in the previous example except that you sell the property at a gain after being allowed depreciation deductions of $37,500. Myfreetaxes org Your adjusted basis for figuring gain is $165,500 ($178,000 + $25,000 (land) − $37,500). Myfreetaxes org Loss. Myfreetaxes org   Figure the basis for a loss starting with the smaller of your adjusted basis or the FMV of the property at the time of the change to business or rental use. Myfreetaxes org Then make adjustments (increases and decreases) for the period after the change in the property's use, as discussed earlier under Adjusted Basis . Myfreetaxes org Example. Myfreetaxes org Assume the same facts as in the previous example, except that you sell the property at a loss after being allowed depreciation deductions of $37,500. Myfreetaxes org In this case, you would start with the FMV on the date of the change to rental use ($180,000), because it is less than the adjusted basis of $203,000 ($178,000 + $25,000 (land)) on that date. Myfreetaxes org Reduce that amount ($180,000) by the depreciation deductions ($37,500). Myfreetaxes org The basis for loss is $142,500 ($180,000 − $37,500). Myfreetaxes org Stocks and Bonds The basis of stocks or bonds you buy generally is the purchase price plus any costs of purchase, such as commissions and recording or transfer fees. Myfreetaxes org If you get stocks or bonds other than by purchase, your basis is usually determined by the FMV or the previous owner's adjusted basis, as discussed earlier. Myfreetaxes org You must adjust the basis of stocks for certain events that occur after purchase. Myfreetaxes org For example, if you receive additional stock from nontaxable stock dividends or stock splits, reduce your basis for each share of stock by dividing the adjusted basis of the old stock by the number of shares of old and new stock. Myfreetaxes org This rule applies only when the additional stock received is identical to the stock held. Myfreetaxes org Also reduce your basis when you receive nontaxable distributions. Myfreetaxes org They are a return of capital. Myfreetaxes org Example. Myfreetaxes org In 2011 you bought 100 shares of XYZ stock for $1,000 or $10 a share. Myfreetaxes org In 2012 you bought 100 shares of XYZ stock for $1,600 or $16 a share. Myfreetaxes org In 2013 XYZ declared a 2-for-1 stock split. Myfreetaxes org You now have 200 shares of stock with a basis of $5 a share and 200 shares with a basis of $8 a share. Myfreetaxes org Other basis. Myfreetaxes org   There are other ways to figure the basis of stocks or bonds depending on how you acquired them. Myfreetaxes org For detailed information, see Stocks and Bonds under Basis of Investment Property in chapter 4 of Publication 550. Myfreetaxes org Identifying stocks or bonds sold. Myfreetaxes org   If you can adequately identify the shares of stock or the bonds you sold, their basis is the cost or other basis of the particular shares of stocks or bonds. Myfreetaxes org If you buy and sell securities at various times in varying quantities and you cannot adequately identify the shares you sell, the basis of the securities you sell is the basis of the securities you acquired first. Myfreetaxes org For more information about identifying securities you sell, see Stocks and Bonds under Basis of Investment Property in chapter 4 of Publication 550. Myfreetaxes org Mutual fund shares. Myfreetaxes org   If you sell mutual fund shares you acquired at various times and prices and left on deposit in an account kept by a custodian or agent, you can elect to use an average basis. Myfreetaxes org For more information, see Publication 550. Myfreetaxes org Bond premium. Myfreetaxes org   If you buy a taxable bond at a premium and elect to amortize the premium, reduce the basis of the bond by the amortized premium you deduct each year. Myfreetaxes org See Bond Premium Amortization in chapter 3 of Publication 550 for more information. Myfreetaxes org Although you cannot deduct the premium on a tax-exempt bond, you must amortize the premium each year and reduce your basis in the bond by the amortized amount. Myfreetaxes org Original issue discount (OID) on debt instruments. Myfreetaxes org   You must increase your basis in an OID debt instrument by the OID you include in income for that instrument. Myfreetaxes org See Original Issue Discount (OID) in chapter 7 and Publication 1212, Guide To Original Issue Discount (OID) Instruments. Myfreetaxes org Tax-exempt obligations. Myfreetaxes org    OID on tax-exempt obligations is generally not taxable. Myfreetaxes org However, when you dispose of a tax-exempt obligation issued after September 3, 1982, and acquired after March 1, 1984, you must accrue OID on the obligation to determine its adjusted basis. Myfreetaxes org The accrued OID is added to the basis of the obligation to determine your gain or loss. Myfreetaxes org See chapter 4 of Publication 550. Myfreetaxes org Prev  Up  Next   Home   More Online Publications
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The Myfreetaxes Org

Myfreetaxes org Publication 936 - Main Content Table of Contents Part I. Myfreetaxes org Home Mortgage InterestSecured Debt Qualified Home Special Situations Points Mortgage Insurance Premiums Form 1098, Mortgage Interest Statement How To Report Special Rule for Tenant-Stockholders in Cooperative Housing Corporations Part II. Myfreetaxes org Limits on Home Mortgage Interest DeductionHome Acquisition Debt Home Equity Debt Grandfathered Debt Table 1 Instructions How To Get Tax HelpLow Income Taxpayer Clinics Part I. Myfreetaxes org Home Mortgage Interest This part explains what you can deduct as home mortgage interest. Myfreetaxes org It includes discussions on points, mortgage insurance premiums, and how to report deductible interest on your tax return. Myfreetaxes org Generally, home mortgage interest is any interest you pay on a loan secured by your home (main home or a second home). Myfreetaxes org The loan may be a mortgage to buy your home, a second mortgage, a line of credit, or a home equity loan. Myfreetaxes org You can deduct home mortgage interest if all the following conditions are met. Myfreetaxes org You file Form 1040 and itemize deductions on Schedule A (Form 1040). Myfreetaxes org The mortgage is a secured debt on a qualified home in which you have an ownership interest. Myfreetaxes org Secured Debt and Qualified Home are explained later. Myfreetaxes org  Both you and the lender must intend that the loan be repaid. Myfreetaxes org Fully deductible interest. Myfreetaxes org   In most cases, you can deduct all of your home mortgage interest. Myfreetaxes org How much you can deduct depends on the date of the mortgage, the amount of the mortgage, and how you use the mortgage proceeds. Myfreetaxes org   If all of your mortgages fit into one or more of the following three categories at all times during the year, you can deduct all of the interest on those mortgages. Myfreetaxes org (If any one mortgage fits into more than one category, add the debt that fits in each category to your other debt in the same category. Myfreetaxes org ) If one or more of your mortgages does not fit into any of these categories, use Part II of this publication to figure the amount of interest you can deduct. Myfreetaxes org   The three categories are as follows. Myfreetaxes org Mortgages you took out on or before October 13, 1987 (called grandfathered debt). Myfreetaxes org Mortgages you took out after October 13, 1987, to buy, build, or improve your home (called home acquisition debt), but only if throughout 2013 these mortgages plus any grandfathered debt totaled $1 million or less ($500,000 or less if married filing separately). Myfreetaxes org Mortgages you took out after October 13, 1987, other than to buy, build, or improve your home (called home equity debt), but only if throughout 2013 these mortgages 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 (1) and (2). Myfreetaxes org The dollar limits for the second and third categories apply to the combined mortgages on your main home and second home. Myfreetaxes org   See Part II for more detailed definitions of grandfathered, home acquisition, and home equity debt. Myfreetaxes org    You can use Figure A to check whether your home mortgage interest is fully deductible. Myfreetaxes org This image is too large to be displayed in the current screen. Myfreetaxes org Please click the link to view the image. Myfreetaxes org Figure A. Myfreetaxes org Is My Home Mortgage Interest Fully Deductible? Secured Debt You can deduct your home mortgage interest only if your mortgage is a secured debt. Myfreetaxes org A secured debt is one in which you sign an instrument (such as a mortgage, deed of trust, or land contract) that: Makes your ownership in a qualified home security for payment of the debt, Provides, in case of default, that your home could satisfy the debt, and Is recorded or is otherwise perfected under any state or local law that applies. Myfreetaxes org In other words, your mortgage is a secured debt if you put your home up as collateral to protect the interests of the lender. Myfreetaxes org If you cannot pay the debt, your home can then serve as payment to the lender to satisfy (pay) the debt. Myfreetaxes org In this publication, mortgage will refer to secured debt. Myfreetaxes org Debt not secured by home. Myfreetaxes org   A debt is not secured by your home if it is secured solely because of a lien on your general assets or if it is a security interest that attaches to the property without your consent (such as a mechanic's lien or judgment lien). Myfreetaxes org   A debt is not secured by your home if it once was, but is no longer secured by your home. Myfreetaxes org Wraparound mortgage. Myfreetaxes org   This is not a secured debt unless it is recorded or otherwise perfected under state law. Myfreetaxes org Example. Myfreetaxes org Beth owns a home subject to a mortgage of $40,000. Myfreetaxes org She sells the home for $100,000 to John, who takes it subject to the $40,000 mortgage. Myfreetaxes org Beth continues to make the payments on the $40,000 note. Myfreetaxes org John pays $10,000 down and gives Beth a $90,000 note secured by a wraparound mortgage on the home. Myfreetaxes org Beth does not record or otherwise perfect the $90,000 mortgage under the state law that applies. Myfreetaxes org Therefore, the mortgage is not a secured debt and John cannot deduct any of the interest he pays on it as home mortgage interest. Myfreetaxes org Choice to treat the debt as not secured by your home. Myfreetaxes org   You can choose to treat any debt secured by your qualified home as not secured by the home. Myfreetaxes org This treatment begins with the tax year for which you make the choice and continues for all later tax years. Myfreetaxes org You can revoke your choice only with the consent of the Internal Revenue Service (IRS). Myfreetaxes org   You may want to treat a debt as not secured by your home if the interest on that debt is fully deductible (for example, as a business expense) whether or not it qualifies as home mortgage interest. Myfreetaxes org This may allow you, if the limits in Part II apply, more of a deduction for interest on other debts that are deductible only as home mortgage interest. Myfreetaxes org Cooperative apartment owner. Myfreetaxes org   If you own stock in a cooperative housing corporation, see the Special Rule for Tenant-Stockholders in Cooperative Housing Corporations , near the end of this Part I. Myfreetaxes org Qualified Home For you to take a home mortgage interest deduction, your debt must be secured by a qualified home. Myfreetaxes org This means your main home or your second home. Myfreetaxes org A home includes a house, condominium, cooperative, mobile home, house trailer, boat, or similar property that has sleeping, cooking, and toilet facilities. Myfreetaxes org The interest you pay on a mortgage on a home other than your main or second home may be deductible if the proceeds of the loan were used for business, investment, or other deductible purposes. Myfreetaxes org Otherwise, it is considered personal interest and is not deductible. Myfreetaxes org Main home. Myfreetaxes org   You can have only one main home at any one time. Myfreetaxes org This is the home where you ordinarily live most of the time. Myfreetaxes org Second home. Myfreetaxes org   A second home is a home that you choose to treat as your second home. Myfreetaxes org Second home not rented out. Myfreetaxes org   If you have a second home that you do not hold out for rent or resale to others at any time during the year, you can treat it as a qualified home. Myfreetaxes org You do not have to use the home during the year. Myfreetaxes org Second home rented out. Myfreetaxes org   If you have a second home and rent it out part of the year, you also must use it as a home during the year for it to be a qualified home. Myfreetaxes org You must use this home more than 14 days or more than 10% of the number of days during the year that the home is rented at a fair rental, whichever is longer. Myfreetaxes org If you do not use the home long enough, it is considered rental property and not a second home. Myfreetaxes org For information on residential rental property, see Publication 527. Myfreetaxes org More than one second home. Myfreetaxes org   If you have more than one second home, you can treat only one as the qualified second home during any year. Myfreetaxes org However, you can change the home you treat as a second home during the year in the following situations. Myfreetaxes org If you get a new home during the year, you can choose to treat the new home as your second home as of the day you buy it. Myfreetaxes org If your main home no longer qualifies as your main home, you can choose to treat it as your second home as of the day you stop using it as your main home. Myfreetaxes org If your second home is sold during the year or becomes your main home, you can choose a new second home as of the day you sell the old one or begin using it as your main home. Myfreetaxes org Divided use of your home. Myfreetaxes org   The only part of your home that is considered a qualified home is the part you use for residential living. Myfreetaxes org If you use part of your home for other than residential living, such as a home office, you must allocate the use of your home. Myfreetaxes org You must then divide both the cost and fair market value of your home between the part that is a qualified home and the part that is not. Myfreetaxes org Dividing the cost may affect the amount of your home acquisition debt, which is limited to the cost of your home plus the cost of any improvements. Myfreetaxes org (See Home Acquisition Debt in Part II. Myfreetaxes org ) Dividing the fair market value may affect your home equity debt limit, also explained in Part II . Myfreetaxes org Renting out part of home. Myfreetaxes org   If you rent out part of a qualified home to another person (tenant), you can treat the rented part as being used by you for residential living only if all of the following conditions apply. Myfreetaxes org The rented part of your home is used by the tenant primarily for residential living. Myfreetaxes org The rented part of your home is not a self-contained residential unit having separate sleeping, cooking, and toilet facilities. Myfreetaxes org You do not rent (directly or by sublease) the same or different parts of your home to more than two tenants at any time during the tax year. Myfreetaxes org If two persons (and dependents of either) share the same sleeping quarters, they are treated as one tenant. Myfreetaxes org Office in home. Myfreetaxes org   If you have an office in your home that you use in your business, see Publication 587, Business Use of Your Home. Myfreetaxes org It explains how to figure your deduction for the business use of your home, which includes the business part of your home mortgage interest. Myfreetaxes org Home under construction. Myfreetaxes org   You can treat a home under construction as a qualified home for a period of up to 24 months, but only if it becomes your qualified home at the time it is ready for occupancy. Myfreetaxes org   The 24-month period can start any time on or after the day construction begins. Myfreetaxes org Home destroyed. Myfreetaxes org   You may be able to continue treating your home as a qualified home even after it is destroyed in a fire, storm, tornado, earthquake, or other casualty. Myfreetaxes org This means you can continue to deduct the interest you pay on your home mortgage, subject to the limits described in this publication. Myfreetaxes org   You can continue treating a destroyed home as a qualified home if, within a reasonable period of time after the home is destroyed, you: Rebuild the destroyed home and move into it, or Sell the land on which the home was located. Myfreetaxes org   This rule applies to your main home and to a second home that you treat as a qualified home. Myfreetaxes org Time-sharing arrangements. Myfreetaxes org   You can treat a home you own under a time-sharing plan as a qualified home if it meets all the requirements. Myfreetaxes org A time-sharing plan is an arrangement between two or more people that limits each person's interest in the home or right to use it to a certain part of the year. Myfreetaxes org Rental of time-share. Myfreetaxes org   If you rent out your time-share, it qualifies as a second home only if you also use it as a home during the year. Myfreetaxes org See Second home rented out , earlier, for the use requirement. Myfreetaxes org To know whether you meet that requirement, count your days of use and rental of the home only during the time you have a right to use it or to receive any benefits from the rental of it. Myfreetaxes org Married taxpayers. Myfreetaxes org   If you are married and file a joint return, your qualified home(s) can be owned either jointly or by only one spouse. Myfreetaxes org Separate returns. Myfreetaxes org   If you are married filing separately and you and your spouse own more than one home, you can each take into account only one home as a qualified home. Myfreetaxes org However, if you both consent in writing, then one spouse can take both the main home and a second home into account. Myfreetaxes org Special Situations This section describes certain items that can be included as home mortgage interest and others that cannot. Myfreetaxes org It also describes certain special situations that may affect your deduction. Myfreetaxes org Late payment charge on mortgage payment. Myfreetaxes org   You can deduct as home mortgage interest a late payment charge if it was not for a specific service performed in connection with your mortgage loan. Myfreetaxes org Mortgage prepayment penalty. Myfreetaxes org   If you pay off your home mortgage early, you may have to pay a penalty. Myfreetaxes org You can deduct that penalty as home mortgage interest provided the penalty is not for a specific service performed or cost incurred in connection with your mortgage loan. Myfreetaxes org Sale of home. Myfreetaxes org   If you sell your home, you can deduct your home mortgage interest (subject to any limits that apply) paid up to, but not including, the date of the sale. Myfreetaxes org Example. Myfreetaxes org John and Peggy Harris sold their home on May 7. Myfreetaxes org Through April 30, they made home mortgage interest payments of $1,220. Myfreetaxes org The settlement sheet for the sale of the home showed $50 interest for the 6-day period in May up to, but not including, the date of sale. Myfreetaxes org Their mortgage interest deduction is $1,270 ($1,220 + $50). Myfreetaxes org Prepaid interest. Myfreetaxes org   If you pay interest in advance for a period that goes beyond the end of the tax year, you must spread this interest over the tax years to which it applies. Myfreetaxes org You can deduct in each year only the interest that qualifies as home mortgage interest for that year. Myfreetaxes org However, there is an exception that applies to points, discussed later. Myfreetaxes org Mortgage interest credit. Myfreetaxes org    You may be able to claim a mortgage interest credit if you were issued a mortgage credit certificate (MCC) by a state or local government. Myfreetaxes org Figure the credit on Form 8396, Mortgage Interest Credit. Myfreetaxes org If you take this credit, you must reduce your mortgage interest deduction by the amount of the credit. Myfreetaxes org   See Form 8396 and Publication 530 for more information on the mortgage interest credit. Myfreetaxes org Ministers' and military housing allowance. Myfreetaxes org   If you are a minister or a member of the uniformed services and receive a housing allowance that is not taxable, you can still deduct your home mortgage interest. Myfreetaxes org Hardest Hit Fund and Emergency Homeowners' Loan Programs. Myfreetaxes org   You can use a special method to compute your deduction for mortgage interest and real estate taxes on your main home if you meet the following two conditions. Myfreetaxes org You received assistance under: A State Housing Finance Agency (State HFA) Hardest Hit Fund program in which program payments could be used to pay mortgage interest, or An Emergency Homeowners' Loan Program administered by the Department of Housing and Urban Development (HUD) or a state. Myfreetaxes org You meet the rules to deduct all of the mortgage interest on your loan and all of the real estate taxes on your main home. Myfreetaxes org If you meet these tests, then you can deduct all of the payments you actually made during the year to your mortgage servicer, the State HFA, or HUD on the home mortgage (including the amount shown on box 3 of Form 1098–MA, Mortgage Assistance Payments), but not more than the sum of the amounts shown on Form 1098, Mortgage Interest Statement, in box 1 (mortgage interest received from payer(s) / borrower(s)), box 4 (mortgage insurance premiums), and box 5 (other information including real property taxes paid). Myfreetaxes org However, you are not required to use this special method to compute your deduction for mortgage interest and real estate taxes on your main home. Myfreetaxes org Mortgage assistance payments under section 235 of the National Housing Act. Myfreetaxes org   If you qualify for mortgage assistance payments for lower-income families under section 235 of the National Housing Act, part or all of the interest on your mortgage may be paid for you. Myfreetaxes org You cannot deduct the interest that is paid for you. Myfreetaxes org No other effect on taxes. Myfreetaxes org   Do not include these mortgage assistance payments in your income. Myfreetaxes org Also, do not use these payments to reduce other deductions, such as real estate taxes. Myfreetaxes org Divorced or separated individuals. Myfreetaxes org   If a divorce or separation agreement requires you or your spouse or former spouse to pay home mortgage interest on a home owned by both of you, the payment of interest may be alimony. Myfreetaxes org See the discussion of Payments for jointly-owned home under Alimony in Publication 504, Divorced or Separated Individuals. Myfreetaxes org Redeemable ground rents. Myfreetaxes org   In some states (such as Maryland), you can buy your home subject to a ground rent. Myfreetaxes org A ground rent is an obligation you assume to pay a fixed amount per year on the property. Myfreetaxes org Under this arrangement, you are leasing (rather than buying) the land on which your home is located. Myfreetaxes org   If you make annual or periodic rental payments on a redeemable ground rent, you can deduct them as mortgage interest. Myfreetaxes org   A ground rent is a redeemable ground rent if all of the following are true. Myfreetaxes org Your lease, including renewal periods, is for more than 15 years. Myfreetaxes org You can freely assign the lease. Myfreetaxes org You have a present or future right (under state or local law) to end the lease and buy the lessor's entire interest in the land by paying a specific amount. Myfreetaxes org The lessor's interest in the land is primarily a security interest to protect the rental payments to which he or she is entitled. Myfreetaxes org   Payments made to end the lease and to buy the lessor's entire interest in the land are not deductible as mortgage interest. Myfreetaxes org Nonredeemable ground rents. Myfreetaxes org   Payments on a nonredeemable ground rent are not mortgage interest. Myfreetaxes org You can deduct them as rent if they are a business expense or if they are for rental property. Myfreetaxes org Reverse mortgages. Myfreetaxes org   A reverse mortgage is a loan where the lender pays you (in a lump sum, a monthly advance, a line of credit, or a combination of all three) while you continue to live in your home. Myfreetaxes org With a reverse mortgage, you retain title to your home. Myfreetaxes org Depending on the plan, your reverse mortgage becomes due with interest when you move, sell your home, reach the end of a pre-selected loan period, or die. Myfreetaxes org Because reverse mortgages are considered loan advances and not income, the amount you receive is not taxable. Myfreetaxes org Any interest (including original issue discount) accrued on a reverse mortgage is not deductible until you actually pay it, which is usually when you pay off the loan in full. Myfreetaxes org Your deduction may be limited because a reverse mortgage loan generally is subject to the limit on Home Equity Debt discussed in Part II. Myfreetaxes org Rental payments. Myfreetaxes org   If you live in a house before final settlement on the purchase, any payments you make for that period are rent and not interest. Myfreetaxes org This is true even if the settlement papers call them interest. Myfreetaxes org You cannot deduct these payments as home mortgage interest. Myfreetaxes org Mortgage proceeds invested in tax-exempt securities. Myfreetaxes org   You cannot deduct the home mortgage interest on grandfathered debt or home equity debt if you used the proceeds of the mortgage to buy securities or certificates that produce tax-free income. Myfreetaxes org “Grandfathered debt” and “home equity debt” are defined in Part II of this publication. Myfreetaxes org Refunds of interest. Myfreetaxes org   If you receive a refund of interest in the same tax year you paid it, you must reduce your interest expense by the amount refunded to you. Myfreetaxes org If you receive a refund of interest you deducted in an earlier year, you generally must include the refund in income in the year you receive it. Myfreetaxes org However, you need to include it only up to the amount of the deduction that reduced your tax in the earlier year. Myfreetaxes org This is true whether the interest overcharge was refunded to you or was used to reduce the outstanding principal on your mortgage. Myfreetaxes org If you need to include the refund in income, report it on Form 1040, line 21. Myfreetaxes org   If you received a refund of interest you overpaid in an earlier year, you generally will receive a Form 1098, Mortgage Interest Statement, showing the refund in box 3. Myfreetaxes org For information about Form 1098, see Form 1098, Mortgage Interest Statement , later. Myfreetaxes org   For more information on how to treat refunds of interest deducted in earlier years, see Recoveries in Publication 525, Taxable and Nontaxable Income. Myfreetaxes org Cooperative apartment owner. Myfreetaxes org   If you own a cooperative apartment, you must reduce your home mortgage interest deduction by your share of any cash portion of a patronage dividend that the cooperative receives. Myfreetaxes org The patronage dividend is a partial refund to the cooperative housing corporation of mortgage interest it paid in a prior year. Myfreetaxes org   If you receive a Form 1098 from the cooperative housing corporation, the form should show only the amount you can deduct. Myfreetaxes org Points The term “points” is used to describe certain charges paid, or treated as paid, by a borrower to obtain a home mortgage. Myfreetaxes org Points may also be called loan origination fees, maximum loan charges, loan discount, or discount points. Myfreetaxes org This image is too large to be displayed in the current screen. Myfreetaxes org Please click the link to view the image. Myfreetaxes org Figure B. Myfreetaxes org Are My Points Fully Deductible This Year? A borrower is treated as paying any points that a home seller pays for the borrower's mortgage. Myfreetaxes org See Points paid by the seller , later. Myfreetaxes org General Rule You generally cannot deduct the full amount of points in the year paid. Myfreetaxes org Because they are prepaid interest, you generally deduct them ratably over the life (term) of the mortgage. Myfreetaxes org See Deduction Allowed Ratably , next. Myfreetaxes org For exceptions to the general rule, see Deduction Allowed in Year Paid , later. Myfreetaxes org Deduction Allowed Ratably If you do not meet the tests listed under Deduction Allowed in Year Paid , later, the loan is not a home improvement loan, or you choose not to deduct your points in full in the year paid, you can deduct the points ratably (equally) over the life of the loan if you meet all the following tests. Myfreetaxes org You use the cash method of accounting. Myfreetaxes org This means you report income in the year you receive it and deduct expenses in the year you pay them. Myfreetaxes org Most individuals use this method. Myfreetaxes org Your loan is secured by a home. Myfreetaxes org (The home does not need to be your main home. Myfreetaxes org ) Your loan period is not more than 30 years. Myfreetaxes org If your loan period is more than 10 years, the terms of your loan are the same as other loans offered in your area for the same or longer period. Myfreetaxes org Either your loan amount is $250,000 or less, or the number of points is not more than: 4, if your loan period is 15 years or less, or 6, if your loan period is more than 15 years. Myfreetaxes org Example. Myfreetaxes org You use the cash method of accounting. Myfreetaxes org In 2013, you took out a $100,000 loan payable over 20 years. Myfreetaxes org The terms of the loan are the same as for other 20-year loans offered in your area. Myfreetaxes org You paid $4,800 in points. Myfreetaxes org You made 3 monthly payments on the loan in 2013. Myfreetaxes org You can deduct $60 [($4,800 ÷ 240 months) x 3 payments] in 2013. Myfreetaxes org In 2014, if you make all twelve payments, you will be able to deduct $240 ($20 x 12). Myfreetaxes org Deduction Allowed in Year Paid You can fully deduct points in the year paid if you meet all the following tests. Myfreetaxes org (You can use Figure B as a quick guide to see whether your points are fully deductible in the year paid. Myfreetaxes org ) Your loan is secured by your main home. Myfreetaxes org (Your main home is the one you ordinarily live in most of the time. Myfreetaxes org ) Paying points is an established business practice in the area where the loan was made. Myfreetaxes org The points paid were not more than the points generally charged in that area. Myfreetaxes org You use the cash method of accounting. Myfreetaxes org This means you report income in the year you receive it and deduct expenses in the year you pay them. Myfreetaxes org Most individuals use this method. Myfreetaxes org The points were not paid in place of amounts that ordinarily are stated separately on the settlement statement, such as appraisal fees, inspection fees, title fees, attorney fees, and property taxes. Myfreetaxes org The funds you provided at or before closing, plus any points the seller paid, were at least as much as the points charged. Myfreetaxes org The funds you provided are not required to have been applied to the points. Myfreetaxes org They can include a down payment, an escrow deposit, earnest money, and other funds you paid at or before closing for any purpose. Myfreetaxes org You cannot have borrowed these funds from your lender or mortgage broker. Myfreetaxes org You use your loan to buy or build your main home. Myfreetaxes org The points were computed as a percentage of the principal amount of the mortgage. Myfreetaxes org The amount is clearly shown on the settlement statement (such as the Settlement Statement, Form HUD-1) as points charged for the mortgage. Myfreetaxes org The points may be shown as paid from either your funds or the seller's. Myfreetaxes org Note. Myfreetaxes org If you meet all of these tests, you can choose to either fully deduct the points in the year paid, or deduct them over the life of the loan. Myfreetaxes org Home improvement loan. Myfreetaxes org   You can also fully deduct in the year paid points paid on a loan to improve your main home, if tests (1) through (6) are met. Myfreetaxes org Second home. Myfreetaxes org You cannot fully deduct in the year paid points you pay on loans secured by your second home. Myfreetaxes org You can deduct these points only over the life of the loan. Myfreetaxes org Refinancing. Myfreetaxes org   Generally, points you pay to refinance a mortgage are not deductible in full in the year you pay them. Myfreetaxes org This is true even if the new mortgage is secured by your main home. Myfreetaxes org   However, if you use part of the refinanced mortgage proceeds to improve your main home and you meet the first 6 tests listed under Deduction Allowed in Year Paid , you can fully deduct the part of the points related to the improvement in the year you paid them with your own funds. Myfreetaxes org You can deduct the rest of the points over the life of the loan. Myfreetaxes org Example 1. Myfreetaxes org In 1998, Bill Fields got a mortgage to buy a home. Myfreetaxes org In 2013, Bill refinanced that mortgage with a 15-year $100,000 mortgage loan. Myfreetaxes org The mortgage is secured by his home. Myfreetaxes org To get the new loan, he had to pay three points ($3,000). Myfreetaxes org Two points ($2,000) were for prepaid interest, and one point ($1,000) was charged for services, in place of amounts that ordinarily are stated separately on the settlement statement. Myfreetaxes org Bill paid the points out of his private funds, rather than out of the proceeds of the new loan. Myfreetaxes org The payment of points is an established practice in the area, and the points charged are not more than the amount generally charged there. Myfreetaxes org Bill's first payment on the new loan was due July 1. Myfreetaxes org He made six payments on the loan in 2013 and is a cash basis taxpayer. Myfreetaxes org Bill used the funds from the new mortgage to repay his existing mortgage. Myfreetaxes org Although the new mortgage loan was for Bill's continued ownership of his main home, it was not for the purchase or improvement of that home. Myfreetaxes org He cannot deduct all of the points in 2013. Myfreetaxes org He can deduct two points ($2,000) ratably over the life of the loan. Myfreetaxes org He deducts $67 [($2,000 ÷ 180 months) × 6 payments] of the points in 2013. Myfreetaxes org The other point ($1,000) was a fee for services and is not deductible. Myfreetaxes org Example 2. Myfreetaxes org The facts are the same as in Example 1, except that Bill used $25,000 of the loan proceeds to improve his home and $75,000 to repay his existing mortgage. Myfreetaxes org Bill deducts 25% ($25,000 ÷ $100,000) of the points ($2,000) in 2013. Myfreetaxes org His deduction is $500 ($2,000 × 25%). Myfreetaxes org Bill also deducts the ratable part of the remaining $1,500 ($2,000 − $500) that must be spread over the life of the loan. Myfreetaxes org This is $50 [($1,500 ÷ 180 months) × 6 payments] in 2013. Myfreetaxes org The total amount Bill deducts in 2013 is $550 ($500 + $50). Myfreetaxes org Special Situations This section describes certain special situations that may affect your deduction of points. Myfreetaxes org Original issue discount. Myfreetaxes org   If you do not qualify to either deduct the points in the year paid or deduct them ratably over the life of the loan, or if you choose not to use either of these methods, the points reduce the issue price of the loan. Myfreetaxes org This reduction results in original issue discount, which is discussed in chapter 4 of Publication 535. Myfreetaxes org Amounts charged for services. Myfreetaxes org    Amounts charged by the lender for specific services connected to the loan are not interest. Myfreetaxes org Examples of these charges are: Appraisal fees, Notary fees, and Preparation costs for the mortgage note or deed of trust. Myfreetaxes org  You cannot deduct these amounts as points either in the year paid or over the life of the mortgage. Myfreetaxes org Points paid by the seller. Myfreetaxes org   The term “points” includes loan placement fees that the seller pays to the lender to arrange financing for the buyer. Myfreetaxes org Treatment by seller. Myfreetaxes org   The seller cannot deduct these fees as interest. Myfreetaxes org But they are a selling expense that reduces the amount realized by the seller. Myfreetaxes org See Publication 523 for information on selling your home. Myfreetaxes org Treatment by buyer. Myfreetaxes org   The buyer reduces the basis of the home by the amount of the seller-paid points and treats the points as if he or she had paid them. Myfreetaxes org If all the tests under Deduction Allowed in Year Paid , earlier, are met, the buyer can deduct the points in the year paid. Myfreetaxes org If any of those tests are not met, the buyer deducts the points over the life of the loan. Myfreetaxes org   If you need information about the basis of your home, see Publication 523 or Publication 530. Myfreetaxes org Funds provided are less than points. Myfreetaxes org   If you meet all the tests in Deduction Allowed in Year Paid , earlier, except that the funds you provided were less than the points charged to you (test (6)), you can deduct the points in the year paid, up to the amount of funds you provided. Myfreetaxes org In addition, you can deduct any points paid by the seller. Myfreetaxes org Example 1. Myfreetaxes org When you took out a $100,000 mortgage loan to buy your home in December, you were charged one point ($1,000). Myfreetaxes org You meet all the tests for deducting points in the year paid, except the only funds you provided were a $750 down payment. Myfreetaxes org Of the $1,000 charged for points, you can deduct $750 in the year paid. Myfreetaxes org You spread the remaining $250 over the life of the mortgage. Myfreetaxes org Example 2. Myfreetaxes org The facts are the same as in Example 1, except that the person who sold you your home also paid one point ($1,000) to help you get your mortgage. Myfreetaxes org In the year paid, you can deduct $1,750 ($750 of the amount you were charged plus the $1,000 paid by the seller). Myfreetaxes org You spread the remaining $250 over the life of the mortgage. Myfreetaxes org You must reduce the basis of your home by the $1,000 paid by the seller. Myfreetaxes org Excess points. Myfreetaxes org   If you meet all the tests in Deduction Allowed in Year Paid , earlier, except that the points paid were more than generally paid in your area (test (3)), you deduct in the year paid only the points that are generally charged. Myfreetaxes org You must spread any additional points over the life of the mortgage. Myfreetaxes org Mortgage ending early. Myfreetaxes org   If you spread your deduction for points over the life of the mortgage, you can deduct any remaining balance in the year the mortgage ends. Myfreetaxes org However, if you refinance the mortgage with the same lender, you cannot deduct any remaining balance of spread points. Myfreetaxes org Instead, deduct the remaining balance over the term of the new loan. Myfreetaxes org   A mortgage may end early due to a prepayment, refinancing, foreclosure, or similar event. Myfreetaxes org Example. Myfreetaxes org Dan paid $3,000 in points in 2002 that he had to spread out over the 15-year life of the mortgage. Myfreetaxes org He deducts $200 points per year. Myfreetaxes org Through 2012, Dan has deducted $2,200 of the points. Myfreetaxes org Dan prepaid his mortgage in full in 2013. Myfreetaxes org He can deduct the remaining $800 of points in 2013. Myfreetaxes org Limits on deduction. Myfreetaxes org   You cannot fully deduct points paid on a mortgage that exceeds the limits discussed in Part II . Myfreetaxes org See the Table 1 Instructions for line 10. Myfreetaxes org Form 1098. Myfreetaxes org    The mortgage interest statement you receive should show not only the total interest paid during the year, but also your deductible points paid during the year. Myfreetaxes org See Form 1098, Mortgage Interest Statement , later. Myfreetaxes org Mortgage Insurance Premiums You can treat amounts you paid during 2013 for qualified mortgage insurance as home mortgage interest. Myfreetaxes org The insurance must be in connection with home acquisition debt, and the insurance contract must have been issued after 2006. Myfreetaxes org Qualified mortgage insurance. Myfreetaxes org   Qualified mortgage insurance is mortgage insurance provided by the Department of Veterans Affairs, the Federal Housing Administration, or the Rural Housing Service, and private mortgage insurance (as defined in section 2 of the Homeowners Protection Act of 1998 as in effect on December 20, 2006). Myfreetaxes org   Mortgage insurance provided by the Department of Veterans Affairs is commonly known as a funding fee. Myfreetaxes org If provided by the Rural Housing Service, it is commonly known as a guarantee fee. Myfreetaxes org The funding fee and guarantee fee can either be included in the amount of the loan or paid in full at the time of closing. Myfreetaxes org These fees can be deducted fully in 2013 if the mortgage insurance contract was issued in 2013. Myfreetaxes org Contact the mortgage insurance issuer to determine the deductible amount if it is not reported in box 4 of Form 1098. Myfreetaxes org Special rules for prepaid mortgage insurance. Myfreetaxes org   Generally, if you paid premiums for qualified mortgage insurance that are properly allocable to periods after the close of the tax year, such premiums are treated as paid in the period to which they are allocated. Myfreetaxes org You must allocate the premiums over the shorter of the stated term of the mortgage or 84 months, beginning with the month the insurance was obtained. Myfreetaxes org No deduction is allowed for the unamortized balance if the mortgage is satisfied before its term. Myfreetaxes org This paragraph does not apply to qualified mortgage insurance provided by the Department of Veterans Affairs or the Rural Housing Service. Myfreetaxes org Example. Myfreetaxes org Ryan purchased a home in May of 2012 and financed the home with a 15-year mortgage. Myfreetaxes org Ryan also prepaid all of the $9,240 in private mortgage insurance required at the time of closing in May. Myfreetaxes org Since the $9,240 in private mortgage insurance is allocable to periods after 2012, Ryan must allocate the $9,240 over the shorter of the life of the mortgage or 84 months. Myfreetaxes org Ryan's adjusted gross income (AGI) for 2012 is $76,000. Myfreetaxes org Ryan can deduct $880 ($9,240 ÷ 84 x 8 months) for qualified mortgage insurance premiums in 2012. Myfreetaxes org For 2013, Ryan can deduct $1,320 ($9,240 ÷ 84 x 12 months) if his AGI is $100,000 or less. Myfreetaxes org In this example, the mortgage insurance premiums are allocated over 84 months, which is shorter than the life of the mortgage of 15 years (180 months). Myfreetaxes org Limit on deduction. Myfreetaxes org   If your adjusted gross income on Form 1040, line 38, is more than $100,000 ($50,000 if your filing status is married filing separately), the amount of your mortgage insurance premiums that are otherwise deductible is reduced and may be eliminated. Myfreetaxes org See Line 13 in the instructions for Schedule A (Form 1040) and complete the Mortgage Insurance Premiums Deduction Worksheet to figure the amount you can deduct. Myfreetaxes org If your adjusted gross income is more than $109,000 ($54,500 if married filing separately), you cannot deduct your mortgage insurance premiums. Myfreetaxes org Form 1098. Myfreetaxes org   The mortgage interest statement you receive should show not only the total interest paid during the year, but also your mortgage insurance premiums paid during the year, which may qualify to be treated as deductible mortgage interest. Myfreetaxes org See Form 1098, Mortgage Interest Statement, next. Myfreetaxes org Form 1098, Mortgage Interest Statement If you paid $600 or more of mortgage interest (including certain points and mortgage insurance premiums) during the year on any one mortgage, you generally will receive a Form 1098 or a similar statement from the mortgage holder. Myfreetaxes org You will receive the statement if you pay interest to a person (including a financial institution or cooperative housing corporation) in the course of that person's trade or business. Myfreetaxes org A governmental unit is a person for purposes of furnishing the statement. Myfreetaxes org The statement for each year should be sent to you by January 31 of the following year. Myfreetaxes org A copy of this form will also be sent to the IRS. Myfreetaxes org The statement will show the total interest you paid during the year, any mortgage insurance premiums you paid, and if you purchased a main home during the year, it also will show the deductible points paid during the year, including seller-paid points. Myfreetaxes org However, it should not show any interest that was paid for you by a government agency. Myfreetaxes org As a general rule, Form 1098 will include only points that you can fully deduct in the year paid. Myfreetaxes org However, certain points not included on Form 1098 also may be deductible, either in the year paid or over the life of the loan. Myfreetaxes org See the earlier discussion of Points to determine whether you can deduct points not shown on Form 1098. Myfreetaxes org Prepaid interest on Form 1098. Myfreetaxes org   If you prepaid interest in 2013 that accrued in full by January 15, 2014, this prepaid interest may be included in box 1 of Form 1098. Myfreetaxes org However, you cannot deduct the prepaid amount for January 2014 in 2013. Myfreetaxes org (See Prepaid interest , earlier. Myfreetaxes org ) You will have to figure the interest that accrued for 2014 and subtract it from the amount in box 1. Myfreetaxes org You will include the interest for January 2014 with other interest you pay for 2014. Myfreetaxes org Refunded interest. Myfreetaxes org   If you received a refund of mortgage interest you overpaid in an earlier year, you generally will receive a Form 1098 showing the refund in box 3. Myfreetaxes org See Refunds of interest , earlier. Myfreetaxes org Mortgage insurance premiums. Myfreetaxes org   The amount of mortgage insurance premiums you paid during 2013 may be shown in Box 4 of Form 1098. Myfreetaxes org See Mortgage Insurance Premiums , earlier. Myfreetaxes org How To Report Deduct the home mortgage interest and points reported to you on Form 1098 on Schedule A (Form 1040), line 10. Myfreetaxes org If you paid more deductible interest to the financial institution than the amount shown on Form 1098, show the larger deductible amount on line 10. Myfreetaxes org Attach a statement explaining the difference and print “See attached” next to line 10. Myfreetaxes org Deduct home mortgage interest that was not reported to you on Form 1098 on Schedule A (Form 1040), line 11. Myfreetaxes org If you paid home mortgage interest to the person from whom you bought your home, show that person's name, address, and taxpayer identification number (TIN) on the dotted lines next to line 11. Myfreetaxes org The seller must give you this number and you must give the seller your TIN. Myfreetaxes org A Form W-9, Request for Taxpayer Identification Number and Certification, can be used for this purpose. Myfreetaxes org Failure to meet any of these requirements may result in a $50 penalty for each failure. Myfreetaxes org The TIN can be either a social security number, an individual taxpayer identification number (issued by the Internal Revenue Service), or an employer identification number. Myfreetaxes org If you can take a deduction for points that were not reported to you on Form 1098, deduct those points on Schedule A (Form 1040), line 12. Myfreetaxes org Deduct mortgage insurance premiums on Schedule A (Form 1040), line 13. Myfreetaxes org More than one borrower. Myfreetaxes org   If you and at least one other person (other than your spouse if you file a joint return) were liable for and paid interest on a mortgage that was for your home, and the other person received a Form 1098 showing the interest that was paid during the year, attach a statement to your return explaining this. Myfreetaxes org Show how much of the interest each of you paid, and give the name and address of the person who received the form. Myfreetaxes org Deduct your share of the interest on Schedule A (Form 1040), line 11, and print “See attached” next to the line. Myfreetaxes org Also, deduct your share of any qualified mortgage insurance premiums on Schedule A (Form 1040), line 13. Myfreetaxes org   Similarly, if you are the payer of record on a mortgage on which there are other borrowers entitled to a deduction for the interest shown on the Form 1098 you received, deduct only your share of the interest on Schedule A (Form 1040), line 10. Myfreetaxes org Let each of the other borrowers know what his or her share is. Myfreetaxes org Mortgage proceeds used for business or investment. Myfreetaxes org   If your home mortgage interest deduction is limited under the rules explained in Part II , but all or part of the mortgage proceeds were used for business, investment, or other deductible activities, see Table 2 near the end of this publication. Myfreetaxes org It shows where to deduct the part of your excess interest that is for those activities. Myfreetaxes org The Table 1 Instructions for line 13 in Part II explain how to divide the excess interest among the activities for which the mortgage proceeds were used. Myfreetaxes org Special Rule for Tenant-Stockholders in Cooperative Housing Corporations A qualified home includes stock in a cooperative housing corporation owned by a tenant-stockholder. Myfreetaxes org This applies only if the tenant-stockholder is entitled to live in the house or apartment because of owning stock in the cooperative. Myfreetaxes org Cooperative housing corporation. Myfreetaxes org   This is a corporation that meets all of the following conditions. Myfreetaxes org Has only one class of stock outstanding, Has no stockholders other than those who own the stock that can live in a house, apartment, or house trailer owned or leased by the corporation, Has no stockholders who can receive any distribution out of capital other than on a liquidation of the corporation, and Meets at least one of the following requirements. Myfreetaxes org Receives at least 80% of its gross income for the year in which the mortgage interest is paid or incurred from tenant-stockholders. Myfreetaxes org For this purpose, gross income is all income received during the entire year, including amounts received before the corporation changed to cooperative ownership. Myfreetaxes org At all times during the year, at least 80% of the total square footage of the corporation's property is used or available for use by the tenant-stockholders for residential or residential-related use. Myfreetaxes org At least 90% of the corporation's expenditures paid or incurred during the year are for the acquisition, construction, management, maintenance, or care of corporate property for the benefit of the tenant-stockholders. Myfreetaxes org Stock used to secure debt. Myfreetaxes org   In some cases, you cannot use your cooperative housing stock to secure a debt because of either: Restrictions under local or state law, or Restrictions in the cooperative agreement (other than restrictions in which the main purpose is to permit the tenant- stockholder to treat unsecured debt as secured debt). Myfreetaxes org However, you can treat a debt as secured by the stock to the extent that the proceeds are used to buy the stock under the allocation of interest rules. Myfreetaxes org See chapter 4 of Publication 535 for details on these rules. Myfreetaxes org Figuring deductible home mortgage interest. Myfreetaxes org   Generally, if you are a tenant-stockholder, you can deduct payments you make for your share of the interest paid or incurred by the cooperative. Myfreetaxes org The interest must be on a debt to buy, build, change, improve, or maintain the cooperative's housing, or on a debt to buy the land. Myfreetaxes org   Figure your share of this interest by multiplying the total by the following fraction. Myfreetaxes org      Your shares of stock in the cooperative   The total shares of stock in the cooperative Limits on deduction. Myfreetaxes org   To figure how the limits discussed in Part II apply to you, treat your share of the cooperative's debt as debt incurred by you. Myfreetaxes org The cooperative should determine your share of its grandfathered debt, its home acquisition debt, and its home equity debt. Myfreetaxes org (Your share of each of these types of debt is equal to the average balance of each debt multiplied by the fraction just given. Myfreetaxes org ) After your share of the average balance of each type of debt is determined, you include it with the average balance of that type of debt secured by your stock. Myfreetaxes org Form 1098. Myfreetaxes org    The cooperative should give you a Form 1098 showing your share of the interest. Myfreetaxes org Use the rules in this publication to determine your deductible mortgage interest. Myfreetaxes org Part II. Myfreetaxes org Limits on Home Mortgage Interest Deduction This part of the publication discusses the limits on deductible home mortgage interest. Myfreetaxes org These limits apply to your home mortgage interest expense if you have a home mortgage that does not fit into any of the three categories listed at the beginning of Part I under Fully deductible interest . Myfreetaxes org Your home mortgage interest deduction is limited to the interest on the part of your home mortgage debt that is not more than your qualified loan limit. Myfreetaxes org This is the part of your home mortgage debt that is grandfathered debt or that is not more than the limits for home acquisition debt and home equity debt. Myfreetaxes org Table 1 can help you figure your qualified loan limit and your deductible home mortgage interest. Myfreetaxes org Home Acquisition Debt Home acquisition debt is a mortgage you took out after October 13, 1987, to buy, build, or substantially improve a qualified home (your main or second home). Myfreetaxes org It also must be secured by that home. Myfreetaxes org If the amount of your mortgage is more than the cost of the home plus the cost of any substantial improvements, only the debt that is not more than the cost of the home plus improvements qualifies as home acquisition debt. Myfreetaxes org The additional debt may qualify as home equity debt (discussed later). Myfreetaxes org Home acquisition debt limit. Myfreetaxes org   The total amount you can treat as home acquisition debt at any time on your main home and second home cannot be more than $1 million ($500,000 if married filing separately). Myfreetaxes org This limit is reduced (but not below zero) by the amount of your grandfathered debt (discussed later). Myfreetaxes org Debt over this limit may qualify as home equity debt (also discussed later). Myfreetaxes org Refinanced home acquisition debt. Myfreetaxes org   Any secured debt you use to refinance home acquisition debt is treated as home acquisition debt. Myfreetaxes org However, the new debt will qualify as home acquisition debt only up to the amount of the balance of the old mortgage principal just before the refinancing. Myfreetaxes org Any additional debt not used to buy, build, or substantially improve a qualified home is not home acquisition debt, but may qualify as home equity debt (discussed later). Myfreetaxes org Mortgage that qualifies later. Myfreetaxes org   A mortgage that does not qualify as home acquisition debt because it does not meet all the requirements may qualify at a later time. Myfreetaxes org For example, a debt that you use to buy your home may not qualify as home acquisition debt because it is not secured by the home. Myfreetaxes org However, if the debt is later secured by the home, it may qualify as home acquisition debt after that time. Myfreetaxes org Similarly, a debt that you use to buy property may not qualify because the property is not a qualified home. Myfreetaxes org However, if the property later becomes a qualified home, the debt may qualify after that time. Myfreetaxes org Mortgage treated as used to buy, build, or improve home. Myfreetaxes org   A mortgage secured by a qualified home may be treated as home acquisition debt, even if you do not actually use the proceeds to buy, build, or substantially improve the home. Myfreetaxes org This applies in the following situations. Myfreetaxes org You buy your home within 90 days before or after the date you take out the mortgage. Myfreetaxes org The home acquisition debt is limited to the home's cost, plus the cost of any substantial improvements within the limit described below in (2) or (3). Myfreetaxes org (See Example 1 later. Myfreetaxes org ) You build or improve your home and take out the mortgage before the work is completed. Myfreetaxes org The home acquisition debt is limited to the amount of the expenses incurred within 24 months before the date of the mortgage. Myfreetaxes org You build or improve your home and take out the mortgage within 90 days after the work is completed. Myfreetaxes org The home acquisition debt is limited to the amount of the expenses incurred within the period beginning 24 months before the work is completed and ending on the date of the mortgage. Myfreetaxes org (See Example 2 later. Myfreetaxes org ) Example 1. Myfreetaxes org You bought your main home on June 3 for $175,000. Myfreetaxes org You paid for the home with cash you got from the sale of your old home. Myfreetaxes org On July 15, you took out a mortgage of $150,000 secured by your main home. Myfreetaxes org You used the $150,000 to invest in stocks. Myfreetaxes org You can treat the mortgage as taken out to buy your home because you bought the home within 90 days before you took out the mortgage. Myfreetaxes org The entire mortgage qualifies as home acquisition debt because it was not more than the home's cost. Myfreetaxes org Example 2. Myfreetaxes org On January 31, John began building a home on the lot that he owned. Myfreetaxes org He used $45,000 of his personal funds to build the home. Myfreetaxes org The home was completed on October 31. Myfreetaxes org On November 21, John took out a $36,000 mortgage that was secured by the home. Myfreetaxes org The mortgage can be treated as used to build the home because it was taken out within 90 days after the home was completed. Myfreetaxes org The entire mortgage qualifies as home acquisition debt because it was not more than the expenses incurred within the period beginning 24 months before the home was completed. Myfreetaxes org This is illustrated by Figure C. Myfreetaxes org   Please click here for the text description of the image. Myfreetaxes org Figure C. Myfreetaxes org John's example Date of the mortgage. Myfreetaxes org   The date you take out your mortgage is the day the loan proceeds are disbursed. Myfreetaxes org This is generally the closing date. Myfreetaxes org You can treat the day you apply in writing for your mortgage as the date you take it out. Myfreetaxes org However, this applies only if you receive the loan proceeds within a reasonable time (such as within 30 days) after your application is approved. Myfreetaxes org If a timely application you make is rejected, a reasonable additional time will be allowed to make a new application. Myfreetaxes org Cost of home or improvements. Myfreetaxes org   To determine your cost, include amounts paid to acquire any interest in a qualified home or to substantially improve the home. Myfreetaxes org   The cost of building or substantially improving a qualified home includes the costs to acquire real property and building materials, fees for architects and design plans, and required building permits. Myfreetaxes org Substantial improvement. Myfreetaxes org   An improvement is substantial if it: Adds to the value of your home, Prolongs your home's useful life, or Adapts your home to new uses. Myfreetaxes org    Repairs that maintain your home in good condition, such as repainting your home, are not substantial improvements. Myfreetaxes org However, if you paint your home as part of a renovation that substantially improves your qualified home, you can include the painting costs in the cost of the improvements. Myfreetaxes org Acquiring an interest in a home because of a divorce. Myfreetaxes org   If you incur debt to acquire the interest of a spouse or former spouse in a home, because of a divorce or legal separation, you can treat that debt as home acquisition debt. Myfreetaxes org Part of home not a qualified home. Myfreetaxes org    To figure your home acquisition debt, you must divide the cost of your home and improvements between the part of your home that is a qualified home and any part that is not a qualified home. Myfreetaxes org See Divided use of your home under Qualified Home in Part I. Myfreetaxes org Home Equity Debt If you took out a loan for reasons other than to buy, build, or substantially improve your home, it may qualify as home equity debt. Myfreetaxes org In addition, debt you incurred to buy, build, or substantially improve your home, to the extent it is more than the home acquisition debt limit (discussed earlier), may qualify as home equity debt. Myfreetaxes org Home equity debt is a mortgage you took out after October 13, 1987, that: Does not qualify as home acquisition debt or as grandfathered debt, and Is secured by your qualified home. Myfreetaxes org Example. Myfreetaxes org You bought your home for cash 10 years ago. Myfreetaxes org You did not have a mortgage on your home until last year, when you took out a $50,000 loan, secured by your home, to pay for your daughter's college tuition and your father's medical bills. Myfreetaxes org This loan is home equity debt. Myfreetaxes org Home equity debt limit. Myfreetaxes org   There is a limit on the amount of debt that can be treated as home equity debt. Myfreetaxes org The total home equity debt on your main home and second home is limited to the smaller of: $100,000 ($50,000 if married filing separately), or The total of each home's fair market value (FMV) reduced (but not below zero) by the amount of its home acquisition debt and grandfathered debt. Myfreetaxes org Determine the FMV and the outstanding home acquisition and grandfathered debt for each home on the date that the last debt was secured by the home. Myfreetaxes org Example. Myfreetaxes org You own one home that you bought in 2000. Myfreetaxes org Its FMV now is $110,000, and the current balance on your original mortgage (home acquisition debt) is $95,000. Myfreetaxes org Bank M offers you a home mortgage loan of 125% of the FMV of the home less any outstanding mortgages or other liens. Myfreetaxes org To consolidate some of your other debts, you take out a $42,500 home mortgage loan [(125% × $110,000) − $95,000] with Bank M. Myfreetaxes org Your home equity debt is limited to $15,000. Myfreetaxes org This is the smaller of: $100,000, the maximum limit, or $15,000, the amount that the FMV of $110,000 exceeds the amount of home acquisition debt of $95,000. Myfreetaxes org Debt higher than limit. Myfreetaxes org   Interest on amounts over the home equity debt limit (such as the interest on $27,500 [$42,500 − $15,000] in the preceding example) generally is treated as personal interest and is not deductible. Myfreetaxes org But if the proceeds of the loan were used for investment, business, or other deductible purposes, the interest may be deductible. Myfreetaxes org If it is, see the Table 1 Instructions for line 13 for an explanation of how to allocate the excess interest. Myfreetaxes org Part of home not a qualified home. Myfreetaxes org   To figure the limit on your home equity debt, you must divide the FMV of your home between the part that is a qualified home and any part that is not a qualified home. Myfreetaxes org See Divided use of your home under Qualified Home in Part I. Myfreetaxes org Fair market value (FMV). Myfreetaxes org    This is the price at which the home would change hands between you and a buyer, neither having to sell or buy, and both having reasonable knowledge of all relevant facts. Myfreetaxes org Sales of similar homes in your area, on about the same date your last debt was secured by the home, may be helpful in figuring the FMV. Myfreetaxes org Grandfathered Debt If you took out a mortgage on your home before October 14, 1987, or you refinanced such a mortgage, it may qualify as grandfathered debt. Myfreetaxes org To qualify, it must have been secured by your qualified home on October 13, 1987, and at all times after that date. Myfreetaxes org How you used the proceeds does not matter. Myfreetaxes org Grandfathered debt is not limited. Myfreetaxes org All of the interest you paid on grandfathered debt is fully deductible home mortgage interest. Myfreetaxes org However, the amount of your grandfathered debt reduces the $1 million limit for home acquisition debt and the limit based on your home's fair market value for home equity debt. Myfreetaxes org Refinanced grandfathered debt. Myfreetaxes org   If you refinanced grandfathered debt after October 13, 1987, for an amount that was not more than the mortgage principal left on the debt, then you still treat it as grandfathered debt. Myfreetaxes org To the extent the new debt is more than that mortgage principal, it is treated as home acquisition or home equity debt, and the mortgage is a mixed-use mortgage (discussed later under Average Mortgage Balance in the Table 1 instructions). Myfreetaxes org The debt must be secured by the qualified home. Myfreetaxes org   You treat grandfathered debt that was refinanced after October 13, 1987, as grandfathered debt only for the term left on the debt that was refinanced. Myfreetaxes org After that, you treat it as home acquisition debt or home equity debt, depending on how you used the proceeds. Myfreetaxes org Exception. Myfreetaxes org   If the debt before refinancing was like a balloon note (the principal on the debt was not amortized over the term of the debt), then you treat the refinanced debt as grandfathered debt for the term of the first refinancing. Myfreetaxes org This term cannot be more than 30 years. Myfreetaxes org Example. Myfreetaxes org Chester took out a $200,000 first mortgage on his home in 1986. Myfreetaxes org The mortgage was a five-year balloon note and the entire balance on the note was due in 1991. Myfreetaxes org Chester refinanced the debt in 1991 with a new 20-year mortgage. Myfreetaxes org The refinanced debt is treated as grandfathered debt for its entire term (20 years). Myfreetaxes org Line-of-credit mortgage. Myfreetaxes org    If you had a line-of-credit mortgage on October 13, 1987, and borrowed additional amounts against it after that date, then the additional amounts are either home acquisition debt or home equity debt depending on how you used the proceeds. Myfreetaxes org The balance on the mortgage before you borrowed the additional amounts is grandfathered debt. Myfreetaxes org The newly borrowed amounts are not grandfathered debt because the funds were borrowed after October 13, 1987. Myfreetaxes org See Average Mortgage Balance in the Table 1 Instructions that follow. Myfreetaxes org Table 1 Instructions Unless you are subject to the overall limit on itemized deductions, you can deduct all of the interest you paid during the year on mortgages secured by your main home or second home in either of the following two situations. Myfreetaxes org All the mortgages are grandfathered debt. Myfreetaxes org The total of the mortgage balances for the entire year is within the limits discussed earlier under Home Acquisition Debt and Home Equity Debt . Myfreetaxes org In either of those cases, you do not need Table 1. Myfreetaxes org Otherwise, you can use Table 1 to determine your qualified loan limit and deductible home mortgage interest. Myfreetaxes org Fill out only one Table 1 for both your main and second home regardless of how many mortgages you have. Myfreetaxes org Table 1. Myfreetaxes org Worksheet To Figure Your Qualified Loan Limit and Deductible Home Mortgage Interest For the Current Year See the Table 1 Instructions. Myfreetaxes org Part I Qualified Loan Limit 1. Myfreetaxes org Enter the average balance of all your grandfathered debt. Myfreetaxes org See line 1 instructions 1. Myfreetaxes org   2. Myfreetaxes org Enter the average balance of all your home acquisition debt. Myfreetaxes org See line 2 instructions 2. Myfreetaxes org   3. Myfreetaxes org Enter $1,000,000 ($500,000 if married filing separately) 3. Myfreetaxes org   4. Myfreetaxes org Enter the larger of the amount on line 1 or the amount on line 3 4. Myfreetaxes org   5. Myfreetaxes org Add the amounts on lines 1 and 2. Myfreetaxes org Enter the total here 5. Myfreetaxes org   6. Myfreetaxes org Enter the smaller of the amount on line 4 or the amount on line 5 6. Myfreetaxes org   7. Myfreetaxes org If you have home equity debt, enter the smaller of $100,000 ($50,000 if married filing separately) or your limited amount. Myfreetaxes org See the line 7 instructions for the limit which may apply to you. Myfreetaxes org 7. Myfreetaxes org   8. Myfreetaxes org Add the amounts on lines 6 and 7. Myfreetaxes org Enter the total. Myfreetaxes org This is your qualified loan limit. Myfreetaxes org 8. Myfreetaxes org   Part II Deductible Home Mortgage Interest 9. Myfreetaxes org Enter the total of the average balances of all mortgages on all qualified homes. Myfreetaxes org  See line 9 instructions 9. Myfreetaxes org     If line 8 is less than line 9, go on to line 10. Myfreetaxes org If line 8 is equal to or more than line 9, stop here. Myfreetaxes org All of your interest on all the mortgages included on line 9 is deductible as home mortgage interest on Schedule A (Form 1040). Myfreetaxes org     10. Myfreetaxes org Enter the total amount of interest that you paid. Myfreetaxes org See line 10 instructions 10. Myfreetaxes org   11. Myfreetaxes org Divide the amount on line 8 by the amount on line 9. Myfreetaxes org Enter the result as a decimal amount (rounded to three places) 11. Myfreetaxes org × . Myfreetaxes org 12. Myfreetaxes org Multiply the amount on line 10 by the decimal amount on line 11. Myfreetaxes org Enter the result. Myfreetaxes org This is your deductible home mortgage interest. Myfreetaxes org Enter this amount on Schedule A (Form 1040) 12. Myfreetaxes org   13. Myfreetaxes org Subtract the amount on line 12 from the amount on line 10. Myfreetaxes org Enter the result. Myfreetaxes org This is not home mortgage interest. Myfreetaxes org See line 13 instructions 13. Myfreetaxes org   Home equity debt only. Myfreetaxes org   If all of your mortgages are home equity debt, do not fill in lines 1 through 5. Myfreetaxes org Enter zero on line 6 and complete the rest of Table 1. Myfreetaxes org Average Mortgage Balance You have to figure the average balance of each mortgage to determine your qualified loan limit. Myfreetaxes org You need these amounts to complete lines 1, 2, and 9 of Table 1. Myfreetaxes org You can use the highest mortgage balances during the year, but you may benefit most by using the average balances. Myfreetaxes org The following are methods you can use to figure your average mortgage balances. Myfreetaxes org However, if a mortgage has more than one category of debt, see Mixed-use mortgages , later, in this section. Myfreetaxes org Average of first and last balance method. Myfreetaxes org   You can use this method if all the following apply. Myfreetaxes org You did not borrow any new amounts on the mortgage during the year. Myfreetaxes org (This does not include borrowing the original mortgage amount. Myfreetaxes org ) You did not prepay more than one month's principal during the year. Myfreetaxes org (This includes prepayment by refinancing your home or by applying proceeds from its sale. Myfreetaxes org ) You had to make level payments at fixed equal intervals on at least a semi-annual basis. Myfreetaxes org You treat your payments as level even if they were adjusted from time to time because of changes in the interest rate. Myfreetaxes org    To figure your average balance, complete the following worksheet. Myfreetaxes org    1. Myfreetaxes org Enter the balance as of the first day of the year that the mortgage was secured by your qualified home during the year (generally January 1)   2. Myfreetaxes org Enter the balance as of the last day of the year that the mortgage was secured by your qualified home during the year (generally December 31)   3. Myfreetaxes org Add amounts on lines 1 and 2   4. Myfreetaxes org Divide the amount on line 3 by 2. Myfreetaxes org Enter the result   Interest paid divided by interest rate method. Myfreetaxes org   You can use this method if at all times in 2013 the mortgage was secured by your qualified home and the interest was paid at least monthly. Myfreetaxes org    Complete the following worksheet to figure your average balance. Myfreetaxes org    1. Myfreetaxes org Enter the interest paid in 2013. Myfreetaxes org Do not include points, mortgage insurance premiums, or any interest paid in 2013 that is for a year after 2013. Myfreetaxes org However, do include interest that is for 2013 but was paid in an earlier year   2. Myfreetaxes org Enter the annual interest rate on the mortgage. Myfreetaxes org If the interest rate varied in 2013, use the lowest rate for the year   3. Myfreetaxes org Divide the amount on line 1 by the amount on line 2. Myfreetaxes org Enter the result   Example. Myfreetaxes org Mr. Myfreetaxes org Blue had a line of credit secured by his main home all year. Myfreetaxes org He paid interest of $2,500 on this loan. Myfreetaxes org The interest rate on the loan was 9% (. Myfreetaxes org 09) all year. Myfreetaxes org His average balance using this method is $27,778, figured as follows. Myfreetaxes org 1. Myfreetaxes org Enter the interest paid in 2013. Myfreetaxes org Do not include points, mortgage insurance premiums, or any interest paid in 2013 that is for a year after 2013. Myfreetaxes org However, do include interest that is for 2013 but was paid in an earlier year $2,500 2. Myfreetaxes org Enter the annual interest rate on the mortgage. Myfreetaxes org If the interest rate varied in 2013, use the lowest rate for the year . Myfreetaxes org 09 3. Myfreetaxes org Divide the amount on line 1 by the amount on line 2. Myfreetaxes org Enter the result $27,778 Statements provided by your lender. Myfreetaxes org   If you receive monthly statements showing the closing balance or the average balance for the month, you can use either to figure your average balance for the year. Myfreetaxes org You can treat the balance as zero for any month the mortgage was not secured by your qualified home. Myfreetaxes org   For each mortgage, figure your average balance by adding your monthly closing or average balances and dividing that total by the number of months the home secured by that mortgage was a qualified home during the year. Myfreetaxes org   If your lender can give you your average balance for the year, you can use that amount. Myfreetaxes org Example. Myfreetaxes org Ms. Myfreetaxes org Brown had a home equity loan secured by her main home all year. Myfreetaxes org She received monthly statements showing her average balance for each month. Myfreetaxes org She can figure her average balance for the year by adding her monthly average balances and dividing the total by 12. Myfreetaxes org Mixed-use mortgages. Myfreetaxes org   A mixed-use mortgage is a loan that consists of more than one of the three categories of debt (grandfathered debt, home acquisition debt, and home equity debt). Myfreetaxes org For example, a mortgage you took out during the year is a mixed-use mortgage if you used its proceeds partly to refinance a mortgage that you took out in an earlier year to buy your home (home acquisition debt) and partly to buy a car (home equity debt). Myfreetaxes org   Complete lines 1 and 2 of Table 1 by including the separate average balances of any grandfathered debt and home acquisition debt in your mixed-use mortgage. Myfreetaxes org Do not use the methods described earlier in this section to figure the average balance of either category. Myfreetaxes org Instead, for each category, use the following method. Myfreetaxes org Figure the balance of that category of debt for each month. Myfreetaxes org This is the amount of the loan proceeds allocated to that category, reduced by your principal payments on the mortgage previously applied to that category. Myfreetaxes org Principal payments on a mixed-use mortgage are applied in full to each category of debt, until its balance is zero, in the following order: First, any home equity debt, Next, any grandfathered debt, and Finally, any home acquisition debt. Myfreetaxes org Add together the monthly balances figured in (1). Myfreetaxes org Divide the result in (2) by 12. Myfreetaxes org   Complete line 9 of Table 1 by including the average balance of the entire mixed-use mortgage, figured under one of the methods described earlier in this section. Myfreetaxes org Example 1. Myfreetaxes org In 1986, Sharon took out a $1,400,000 mortgage to buy her main home (grandfathered debt). Myfreetaxes org On March 2, 2013, when the home had a fair market value of $1,700,000 and she owed $1,100,000 on the mortgage, Sharon took out a second mortgage for $200,000. Myfreetaxes org She used $180,000 of the proceeds to make substantial improvements to her home (home acquisition debt) and the remaining $20,000 to buy a car (home equity debt). Myfreetaxes org Under the loan agreement, Sharon must make principal payments of $1,000 at the end of each month. Myfreetaxes org During 2013, her principal payments on the second mortgage totaled $10,000. Myfreetaxes org To complete Table 1, line 2, Sharon must figure a separate average balance for the part of her second mortgage that is home acquisition debt. Myfreetaxes org The January and February balances were zero. Myfreetaxes org The March through December balances were all $180,000, because none of her principal payments are applied to the home acquisition debt. Myfreetaxes org (They are all applied to the home equity debt, reducing it to $10,000 [$20,000 − $10,000]. Myfreetaxes org ) The monthly balances of the home acquisition debt total $1,800,000 ($180,000 × 10). Myfreetaxes org Therefore, the average balance of the home acquisition debt for 2013 was $150,000 ($1,800,000 ÷ 12). Myfreetaxes org Example 2. Myfreetaxes org The facts are the same as in Example 1. Myfreetaxes org In 2014, Sharon's January through October principal payments on her second mortgage are applied to the home equity debt, reducing it to zero. Myfreetaxes org The balance of the home acquisition debt remains $180,000 for each of those months. Myfreetaxes org Because her November and December principal payments are applied to the home acquisition debt, the November balance is $179,000 ($180,000 − $1,000) and the December balance is $178,000 ($180,000 − $2,000). Myfreetaxes org The monthly balances total $2,157,000 [($180,000 × 10) + $179,000 + $178,000]. Myfreetaxes org Therefore, the average balance of the home acquisition debt for 2014 is $179,750 ($2,157,000 ÷ 12). Myfreetaxes org L