Some Thoughts on the Mortgage Deduction

The deduction for mortgage interest is one of the most popular and well-known tax breaks available. A little less known is that the deduction has some limits, which generated a recent question on the message boards.

The basic idea is you can deduct interest on a loan of up to a $1 million if the proceeds are used to buy, build, or improve a home. You can also deduct interest on a home equity loan of up to $100,000. In the tax law, a home equity loan is any loan whose proceeds are not used to buy, build or improve a home. So most people naturally remember this $1.1 million dollar limit.

The question posed by the reader got me to thinking. There's another limit for home equity loans. The interest may not be deductible if the loan amount exceeds the fair market value of the home. And that means some people who have seen their homes decrease in value might end up with mortgage interest that isn't fully deductible. That's a heart-wrenching thought when every dollar of tax savings can really help. The point to remember is this only applies to home equity loans, not to "acquisition debt." So if you're home as declined in value and your only loans were for buying, building, or improving the house, then you will be able to continue deducting your interest.