23.   Interest Expense

Table of Contents

    * Reminders
    * Introduction
    * Useful Items - You may want to see:
    * Home Mortgage Interest
          o Amount Deductible
          o Points
          o Mortgage Interest Statement
    * Investment Interest
          o Investment Property
          o Allocation of Interest Expense
          o Limit on Deduction
    * Items You Cannot Deduct
          o Personal Interest
    * Allocation of Interest
    * How To Report
          o More than one borrower.
          o Mortgage proceeds used for business or investment.

Reminders

Personal interest.  Personal interest is not deductible. Examples of
personal interest include interest on a loan to purchase an automobile for
personal use and credit card and installment interest incurred for personal
expenses. But you may be able to deduct interest you pay on a qualified
student loan. For details, see Publication 970, Tax Benefits for Education.

Limit on itemized deductions.  If your adjusted gross income is more than
$145,950 ($72,975 if you are married filing separately), the overall amount
of your itemized deductions may be limited. See chapter 29 for more
information about this limit.
Introduction

This chapter discusses interest. Interest is the amount you pay for the use
of borrowed money.

The types of interest you can deduct as itemized deductions on Schedule A
(Form 1040) are:

    *

      Home mortgage interest, including certain points, and
    *

      Investment interest.

This chapter explains these deductions. It also explains where to deduct
other types of interest and lists some types of interest you cannot deduct.

Use Table 23-1 to find out where to get more information on various types
of interest, including investment interest.
Useful Items - You may want to see:

Publication

    *

      936 Home Mortgage Interest Deduction

Home Mortgage Interest

Generally, home mortgage interest is any interest you pay on a loan secured
by your home (main home or a second home). The loan may be a mortgage to
buy your home, a second mortgage, a line of credit, or a home equity loan.

You can deduct home mortgage interest only if you meet all the following
conditions.

    *

      You must file Form 1040 and itemize deductions on Schedule A (Form 1040).
    *

      You must be legally liable for the loan. You cannot deduct payments
you make for someone else if you are not legally liable to make them. Both
you and the lender must intend that the loan be repaid. In addition, there
must be a true debtor-creditor relationship between you and the lender.
    *

      The mortgage must be a secured debt on a qualified home. (Generally,
your mortgage is a secured debt if you put your home up as collateral to
protect the interests of the lender. The term “qualified home” means your
main home or second home. For details, see Publication 936.)

Amount Deductible

In most cases, you will be able to deduct all of your home mortgage
interest. Whether you can deduct all of it depends on the date you took out
the mortgage, the amount of the mortgage, and your use of its proceeds.
Fully deductible interest.   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. (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.)

  The three categories are:

   1.

      Mortgages you took out on or before October 13, 1987 (called
grandfathered debt).
   2.

      Mortgages you took out after October 13, 1987, to buy, build, or
improve your home (called home acquisition debt), but only if throughout
2005 these mortgages plus any grandfathered debt totaled $1 million or less
($500,000 or less if married filing separately).
   3.

      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 2005 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).

  The dollar limits for the second and third categories apply to the
combined mortgages on your main home and second home.

  See Part II of Publication 936 for more detailed definitions of
grandfathered, home acquisition, and home equity debt.

   You can use Figure 23-A to check whether your home mortgage interest is
fully deductible.
This image is too large to be displayed in the current screen. Please click
the link to view the image.

Figure 25-A. Is My Interest Fully Deductible?

Limits on deduction.   You cannot fully deduct interest on a mortgage that
does not fit into any of the three categories listed above. If this applies
to you, see Part II of Publication 936 to figure the amount of interest you
can deduct.

Special Situations

This section describes certain items that can be included as home mortgage
interest and others that cannot. It also describes certain special
situations that may affect your deduction.
Late payment charge on mortgage payment.   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.

Mortgage prepayment penalty.   If you pay off your home mortgage early, you
may have to pay a penalty. 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.

Sale of home.   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 sale.

Example.

John and Peggy Harris sold their home on May 7. Through April 30, they made
home mortgage interest payments of $1,220. 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. Their mortgage interest deduction is
$1,270 ($1,220 + $50).
Prepaid interest.   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. You can deduct in each year only the interest
that qualifies as home mortgage interest for that year. However, see
Points, later.

Mortgage interest credit.   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. Figure the credit on Form 8396, Mortgage Interest Credit.
If you take this credit, you must reduce your mortgage interest deduction
by the amount of the credit.

  For more information on the credit, see chapter 37.

Ministers' and military housing allowance.   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.

Mortgage assistance payments.   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. You cannot deduct the interest that is paid for you.

No other effect on taxes.   Do not include these mortgage assistance
payments in your income. Also, do not use these payments to reduce other
deductions, such as real estate taxes.

Divorced or separated individuals.   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. See
the discussion of Payments for jointly-owned home in chapter 18.

Redeemable ground rent.   If you make annual or periodic rental payments on
a redeemable ground rent, you can deduct them as mortgage interest.

  Payments made to end the lease and to buy the lessor's entire interest in
the land are not ground rents. You cannot deduct them. For more
information, see Publication 936.

Nonredeemable ground rents .   Payments on a nonredeemable ground rent are
not mortgage interest. You can deduct them as rent if they are a business
expense or if they are for rental property.

Rental payments.   If you live in a house before final settlement on the
purchase, any payments you make for that period are rent and not interest.
This is true even if the settlement papers call them interest. You cannot
deduct these payments as home mortgage interest.

Mortgage proceeds invested in tax-exempt securities.   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. “Grandfathered debt” and “home equity debt” are
defined earlier under Amount Deductible.

Refunds of interest.   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. 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. However, you need to include it only up to the amount of
the deduction that reduced your tax in the earlier year. This is true
whether the interest overcharge was refunded to you or was used to reduce
the outstanding principal on your mortgage.

   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. For information about Form 1098, see Mortgage
Interest Statement, later.

  For more information on how to treat refunds of interest deducted in
earlier years, see Recoveries in chapter 12.

Points

The term “points” is used to describe certain charges paid, or treated as
paid, by a borrower to obtain a home mortgage. Points may also be called
loan origination fees, maximum loan charges, loan discount, or discount points.

A borrower is treated as paying any points that a home seller pays for the
borrower's mortgage. See Points paid by the seller, later.
General rule.   You generally cannot deduct the full amount of points in
the year paid. Because they are prepaid interest, you generally deduct them
ratably over the life (term) of the mortgage. See Deduction allowed
ratably, later.

  For exceptions to the general rule, see Deduction allowed in year paid, next.

Deduction allowed in year paid.    You can fully deduct points in the year
paid if you meet all the following tests. (You can use Figure 23-B as a
quick guide to see whether your points are fully deductible in the year paid.)

   1.

      Your loan is secured by your main home. (Your main home is the one
you live in most of the time.)
   2.

      Paying points is an established business practice in the area where
the loan was made.
   3.

      The points paid were not more than the points generally charged in
that area.
   4.

      You use the cash method of accounting. This means you report income
in the year you receive it and deduct expenses in the year you pay them.
(If you want more information about this method, see Accounting Methods in
chapter 1.)
   5.

      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.
   6.

      The funds you provided at or before closing, plus any points the
seller paid, were at least as much as the points charged. The funds you
provided do not have to have been applied to the points. They can include a
down payment, an escrow deposit, earnest money, and other funds you paid at
or before closing for any purpose. You cannot have borrowed these funds
from your lender or mortgage broker.
   7.

      You use your loan to buy or build your main home.
   8.

      The points were computed as a percentage of the principal amount of
the mortgage.
   9.

      The amount is clearly shown on the settlement statement (such as the
Settlement Statement, Form HUD-1) as points charged for the mortgage. The
points may be shown as paid from either your funds or the seller's.

This image is too large to be displayed in the current screen. Please click
the link to view the image.

Figure 25–B. Are My Points Fully Deductible This Year?

Note.

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.
Home improvement loan.   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.

Caution
Second home. You cannot fully deduct in the year paid points you pay on
loans secured by your second home. You can deduct these points only over
the life of the loan.
Refinancing.   Generally, points you pay to refinance a mortgage are not
deductible in full in the year you pay them. This is true even if the new
mortgage is secured by your main home.

  However, if you use part of the refinanced mortgage proceeds to improve
your main home and you meet the first six tests listed under Deduction
allowed in year paid, earlier, you can fully deduct the part of the points
related to the improvement in the year you paid them with your own funds.
You can deduct the rest of the points over the life of the loan.

Example 1.

In 1992, Bill Fields got a mortgage to buy a home. In 2005, Bill refinanced
that mortgage with a 15-year $100,000 mortgage loan. The mortgage is
secured by his home. To get the new loan, he had to pay three points
($3,000). 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. Bill paid the points out of
his private funds, rather than out of the proceeds of the new loan. The
payment of points is an established practice in the area, and the points
charged are not more than the amount generally charged there. Bill's first
payment on the new loan was due July 1. He made six payments on the loan in
2005 and is a cash basis taxpayer.

Bill used the funds from the new mortgage to repay his existing mortgage.
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. He
cannot deduct all of the points in 2005. He can deduct two points ($2,000)
ratably over the life of the loan. He deducts $67 [($2,000 ÷ 180 months) ×
6 payments] of the points in 2005. The other point ($1,000) was a fee for
services and is not deductible.

Example 2.

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. Bill deducts 25% ($25,000 ÷ $100,000) of the points ($2,000) in
2005. His deduction is $500 ($2,000 × 25%).

Bill also deducts the ratable part of the remaining $1,500 ($2,000 - $500)
that must be spread over the life of the loan. This is $50 [($1,500 ÷ 180
months) × 6 payments] in 2005. The total amount Bill deducts in 2005 is
$550 ($500 + $50).
Deduction allowed ratably.   If you do not meet the tests above under
Deduction allowed in year paid, 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.

   1.

      You use the cash method of accounting. This means you report income
in the year you receive it and deduct expenses in the year you pay them.
Most individuals use this method.
   2.

      Your loan is secured by a home. (The home does not need to be your
main home.)
   3.

      Your loan period is not more than 30 years.
   4.

      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.
   5.

      Either your loan amount is $250,000 or less, or the number of points
is not more than:
         1.

            4, if your loan period is 15 years or less, or
         2.

            6, if your loan period is more than 15 years.

Original issue discount.   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. This reduction results in original issue discount,
which is discussed in chapter 5 of Publication 535.

Amounts charged for services.   Amounts charged by the lender for specific
services connected to the loan are not interest. Examples of these charges are:

    *

      Appraisal fees,
    *

      Notary fees,
    *

      Preparation costs for the mortgage note or deed of trust,
    *

      Mortgage insurance premiums, and
    *

      VA funding fees.

You cannot deduct these amounts as points either in the year paid or over
the life of the mortgage. For information about the tax treatment of these
amounts and other settlement fees and closing costs, get Publication 530,
Tax Information for First-Time Homeowners.

Points paid by the seller.   The term “points” includes loan placement fees
that the seller pays to the lender to arrange financing for the buyer.

Treatment by seller.   The seller cannot deduct these fees as interest.
They are a selling expense that reduces the amount realized by the seller.
See chapter 15 for information on the sale of your home.

Treatment by buyer.    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. If all the tests under Deduction allowed in year paid, earlier,
are met, the buyer can deduct the points in the year paid. If any of those
tests is not met, the buyer deducts the points over the life of the loan.

  For information about basis, see chapter 13.

Funds provided are less than points.   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. In
addition, you can deduct any points paid by the seller.

Example 1.

When you took out a $100,000 mortgage loan to buy your home in December,
you were charged one point ($1,000). You meet all the tests for deducting
points in the year paid, except the only funds you provided were a $750
down payment. Of the $1,000 charged for points, you can deduct $750 in the
year paid. You spread the remaining $250 over the life of the mortgage.

Example 2.

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. In
the year paid, you can deduct $1,750 ($750 of the amount you were charged
plus the $1,000 paid by the seller). You spread the remaining $250 over the
life of the mortgage. You must reduce the basis of your home by the $1,000
paid by the seller.
Excess points.   If you meet all the tests in Deduction allowed in year
paid, earlier, except that the points paid were more than are generally
paid in your area (test 3), you deduct in the year paid only the points
that are generally charged. You must spread any additional points over the
life of the mortgage.

Mortgage ending early.   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. However, if you refinance the mortgage with the same lender,
you cannot deduct any remaining balance of spread points. Instead, deduct
the remaining balance over the term of the new loan.

   A mortgage may end early due to a prepayment, refinancing, foreclosure,
or similar event.

Example.

Dan paid $3,000 in points in 1995 that he had to spread out over the
15-year life of the mortgage. He had deducted $2,000 of these points
through 2004.

Dan prepaid his mortgage in full in 2005. He can deduct the remaining
$1,000 of points in 2005.
Limits on deduction.   You cannot fully deduct points on a mortgage unless
the mortgage fits into one of the categories listed earlier under Fully
deductible interest. See Publication 936 for details.

Mortgage Interest Statement

If you paid $600 or more of mortgage interest (including certain points)
during the year on any one mortgage, you generally will receive a Form
1098, Mortgage Interest Statement, or a similar statement from the mortgage
holder. You will receive the statement if you pay interest to a person
(including a financial institution or a cooperative housing corporation) in
the course of that person's trade or business. A governmental unit is a
person for purposes of furnishing the statement.

The statement for each year should be sent to you by January 31 of the
following year. A copy of this form will also be sent to the IRS.

The statement will show the total interest you paid during the year. If you
purchased a main home during the year, it will also show the deductible
points paid during the year, including seller-paid points. However, it
should not show any interest that was paid for you by a government agency.

As a general rule, Form 1098 will include only points that you can fully
deduct in the year paid. However, certain points not included on Form 1098
also may be deductible, either in the year paid or over the life of the
loan. See Points, earlier, to determine whether you can deduct points not
shown on Form 1098.
Prepaid interest on Form 1098.   If you prepaid interest in 2005 that
accrued in full by January 15, 2006, this prepaid interest may be included
in box 1 of Form 1098. However, you cannot deduct the prepaid amount for
January 2006 in 2005. (See Prepaid interest, earlier.) You will have to
figure the interest that accrued for 2006 and subtract it from the amount
in box 1. You will include the interest for January 2006 with the other
interest you pay for 2006. See How To Report, later.

Refunded interest.   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. See Refunds of interest, earlier.

Investment Interest

This section discusses the interest expenses you may be able to deduct as
an investor.

If you borrow money to buy property you hold for investment, the interest
you pay is investment interest. You can deduct investment interest subject
to the limit discussed later. However, you cannot deduct interest you
incurred to produce tax-exempt income. Nor can you deduct interest expenses
on straddles.

Investment interest does not include any qualified home mortgage interest
or any interest taken into account in computing income or loss from a
passive activity.
Investment Property

Property held for investment includes property that produces interest,
dividends, annuities, or royalties not derived in the ordinary course of a
trade or business. It also includes property that produces gain or loss
(not derived in the ordinary course of a trade or business) from the sale
or trade of property producing these types of income or held for investment
(other than an interest in a passive activity). Investment property also
includes an interest in a trade or business activity in which you did not
materially participate (other than a passive activity).
Partners, shareholders, and beneficiaries.   To determine your investment
interest, combine your share of investment interest from a partnership, S
corporation, estate, or trust with your other investment interest.

Allocation of Interest Expense

If you borrow money for business or personal purposes as well as for
investment, you must allocate the debt among those purposes. Only the
interest expense on the part of the debt used for investment purposes is
treated as investment interest. The allocation is not affected by the use
of property that secures the debt.
Limit on Deduction

Generally, your deduction for investment interest expense is limited to the
amount of your net investment income.

You can carry over to the next tax year the amount of investment interest
that you could not deduct because of this limit. The interest carried over
is treated as investment interest paid or accrued in that next year.

You can carry over disallowed investment interest to the next tax year even
if it is more than your taxable income in the year the interest was paid or
accrued.
Net Investment Income

Determine the amount of your net investment income by subtracting your
investment expenses (other than interest expense) from your investment income.
Investment income.    This generally includes your gross income from
property held for investment (such as interest, dividends, annuities, and
royalties). Investment income does not include Alaska Permanent Fund
dividends. It also does not include qualified dividends or capital gain
distributions unless you choose to include them.

Choosing to include qualified dividends.   Investment income generally does
not include qualified dividends (discussed in chapter 8). However, you can
choose to include all or part of your qualified dividends in investment income.

  You make this choice by completing Form 4952, line 4g, according to its
instructions.

  If you choose to include any amount of your qualified dividends in
investment income, you must reduce your qualified dividends that are
eligible for the lower capital gains tax rates by the same amount.

Choosing to include net capital gain.   Investment income generally does
not include net capital gain from disposing of investment property
(including capital gain distributions from mutual funds). However, you can
choose to include all or part of your net capital gain in investment income.

   You make this choice by completing Form 4952, line 4g, according to its
instructions.

  If you choose to include any amount of your net capital gain in
investment income, you must reduce your net capital gain that is eligible
for the lower capital gains tax rates by the same amount.

  
Tip
Before making either choice, consider the overall effect on your tax
liability. Compare your tax if you make one or both of these choices with
your tax if you do not.

Investment income of child reported on parent's return.    Investment
income includes the part of your child's interest and dividend income that
you choose to report on your return. If the child does not have qualified
dividends, Alaska Permanent Fund dividends, or capital gain distributions,
this is the amount on line 6 of Form 8814, Parents' Election To Report
Child's Interest and Dividends.

Child's qualified dividends.   If part of the amount you report is your
child's qualified dividends, that part (which is reported on line 9b of
Form 1040 or Form 1040A) generally does not count as investment income.
However, you can choose to include all or part of it in investment income,
as explained under Choosing to include qualified dividends, earlier.

  Your investment income also includes the amount on Form 8814, line 6,
(or, if applicable, the amount figured next under Child's Alaska Permanent
Fund dividends).

Child's Alaska Permanent Fund dividends.   If part of the amount you report
is your child's Alaska Permanent Fund dividends, that part does not count
as investment income. To figure the amount of your child's income that you
can consider your investment income, start with the amount on Form 8814,
line 6. Multiply that amount by a percentage that is equal to the Alaska
Permanent Fund dividends divided by the total amount of interest and
dividend income on Form 8814, lines 1a and 2. Subtract the result from the
amount on Form 8814, line 6.

Child's capital gain distributions.    If part of the amount you report is
your child's capital gain distributions, that part (which is reported on
Schedule D, line 13 or Form 1040, line 13) generally does not count as
investment income. However, you can choose to include all or part of it in
investment income, as explained in Choosing to include net capital gain,
earlier.

  Your investment income also includes the amount on Form 8814, line 6,
(or, if applicable, the amount figured under Child's Alaska Permanent Fund
dividends, earlier).

Investment expenses.   Investment expenses include all income-producing
expenses (other than interest expense) relating to investment property that
are allowable deductions after applying the 2% limit that applies to
miscellaneous itemized deductions. Use the smaller of:

   1.

      The investment expenses included on Schedule A (Form 1040), line 22, or
   2.

      The amount on Schedule A, line 26.

Losses from passive activities.   Income or expenses that you used in
computing income or loss from a passive activity are not included in
determining your investment income or investment expenses (including
investment interest expense). See Publication 925, Passive Activity and
At-Risk Rules, for information about passive activities.

Form 4952

Use Form 4952, Investment Interest Expense Deduction, to figure your
deduction for investment interest.
Exception to use of Form 4952.   You do not have to complete Form 4952 or
attach it to your return if you meet all of the following tests.

    *

      Your investment interest expense is not more than your investment
income from interest and ordinary dividends minus any qualified dividends.
    *

      You have no other deductible investment expenses.
    *

      You have no disallowed investment interest expense from 2004.

If you meet all of these tests, you can deduct all of your investment interest.

More Information

For more information on investment interest, see Investment Expenses in
chapter 3 of Publication 550.
Items You Cannot Deduct

Some interest payments are not deductible. Certain expenses similar to
interest also are not deductible. Nondeductible expenses include the
following items.

    *

      Personal interest (discussed later).
    *

      Service charges (however, see Other Expenses in chapter 28).
    *

      Annual fees for credit cards.
    *

      Loan fees.
    *

      Credit investigation fees.
    *

      FHA mortgage insurance premiums and VA funding fees.
    *

      Interest to purchase or carry tax-exempt securities.

Penalties.   You cannot deduct fines and penalties paid to a government for
violations of law, regardless of their nature.

Personal Interest

Personal interest is not deductible. Personal interest is any interest that
is not home mortgage interest, investment interest, business interest, or
other deductible interest. It includes the following items.

    *

      Interest on car loans (unless you use the car for business).
    *

      Interest on federal, state, or local income tax.
    *

      Finance charges on credit cards, retail installment contracts, and
revolving charge accounts incurred for personal expenses.
    *

      Late payment charges by a public utility.

Tip
You may be able to deduct interest you pay on a qualified student loan. For
details, see Publication 970.
Allocation of Interest

If you use the proceeds of a loan for more than one purpose (for example,
personal and business), you must allocate the interest on the loan to each
use. However, you do not have to allocate home mortgage interest if it is
fully deductible, regardless of how the funds are used.

You allocate interest (other than fully deductible home mortgage interest)
on a loan in the same way as the loan itself is allocated. You do this by
tracing disbursements of the debt proceeds to specific uses. For details on
how to do this, see chapter 5 of Publication 535.
How To Report

You must file Form 1040 to deduct any home mortgage interest or investment
interest on your tax return. Where you deduct your interest expense
generally depends on how you use the loan proceeds. See Table 23-1 for a
summary of where to deduct your interest expense.
Home mortgage interest and points.   Deduct the home mortgage interest and
points reported to you on Form 1098 on Schedule A (Form 1040), line 10. 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.
Attach a statement explaining the difference and print “See attached” next
to line 10.

   Deduct home mortgage interest that was not reported to you on Form 1098
on Schedule A (Form 1040), line 11. 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. The seller must give you this number and you must give the
seller your TIN. A Form W-9 can be used for this purpose. Failure to meet
any of these requirements may result in a $50 penalty for each failure. 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. See Social Security Number in chapter 1 for
more information about TINs.

   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.

More than one borrower.   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. Show how much of the interest each of you
paid, and give the name and address of the person who received the form.
Deduct your share of the interest on Schedule A (Form 1040), line 11, and
print “See attached” next to the line.

  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. You should let each of the other borrowers know
what his or her share is.

Mortgage proceeds used for business or investment.    If your home mortgage
interest deduction is limited but all or part of the mortgage proceeds were
used for business, investment, or other deductible activities, see Table
23-1. It shows where to deduct the part of your excess interest that is for
those activities.

Investment interest.    Deduct investment interest, subject to certain
limits discussed in Publication 550, on Schedule A (Form 1040), line 13.

Amortization of bond premium.   There are various ways to treat the premium
you pay to buy taxable bonds. See Bond Premium Amortization in Publication 550.

Income-producing rental or royalty interest.   Deduct interest on a loan
for income-producing rental or royalty property that is not used in your
business in Part I of Schedule E (Form 1040).

Example.

You rent out part of your home and borrow money to make repairs. You can
deduct only the interest payment for the rented part in Part I of Schedule
E (Form 1040). Deduct the rest of the interest payment on Schedule A (Form
1040) if it is deductible home mortgage interest.

Table 23-1. Where To Deduct Your Interest Expense
IF you have ... 	THEN deduct it on ... 	AND for more information go to ...
Deductible student loan interest 	Form 1040, line 33 or Form 1040A, line
18 	Publication 970
Deductible home mortgage interest and points reported on Form 1098 
Schedule A (Form 1040), line 10 	Publication 936
Deductible home mortgage interest not reported on Form 1098 	Schedule A
(Form 1040), line 11 	Publication 936
Deductible points not reported on Form 1098 	Schedule A (Form 1040), line
12 	Publication 936
Deductible investment interest (other than interest incurred to produce
rents or royalties) 	Schedule A (Form 1040), line 13 	Publication 550
Deductible business interest (non-farm) 	Schedule C or C-EZ (Form 1040) 
Publication 535
Deductible farm business interest 	Schedule F (Form 1040) 	Publications 225
and 535
Deductible interest incurred to produce rents or royalties 	Schedule E
(Form 1040) 	Publications 527 and 535
Personal interest 	Not Deductible