Your mortgage deductions interest the IRS

A 1040 form and a sharpened pencil
  • Some taxpayers are deducting interest that seems too large for their income.
  • In an audit, the IRS is going to examine the source of the money.
  • If you are using funds for home improvements, keep receipts and records.

If you were one of the eager buyers during the housing boom who purchased with a "no income verification" mortgage, or if you tapped cash when lenders let you use your home as an ATM, you're lucky if you have been able to stretch your budget to meet mortgage payments.

Now, if you plan to deduct mortgage interest that seems too large for your income, the IRS may come calling to find out just how you've pulled it off.

Last August, the Treasury Inspector General for Tax Administration, or TIGTA, released a study showing that Form 1098, which details the total amount of mortgage interest paid in a tax year and is supplied by mortgage lenders to their individual customers and the IRS, could uncover many individuals who were either not reporting their full income or not filing an income tax return at all.

Common sense dictates that anyone who pays a certain amount of mortgage interest should also be reporting an income that's large enough to support that payment, as well as other living expenses.

If you're cheating on taxes, the 1098 could out you -- if not this year, soon. The IRS has responded to the TIGTA memorandum saying it has formed a task force to study how mortgage interest can be used more fully in its enforcement efforts.

When the IRS audits an individual, they typically dig back a few years into records, says Benson Goldstein, senior technical manager at the American Institute of Certified Public Accountants, or AICPA.

Given the exotic mortgages prevalent earlier in this decade, it's feasible that many taxpayers could be honestly filing their taxes, but they're claiming interest deductions that seem too large for their income, adds Tom Ochsenschlager, vice president, AICPA.

Keep records

In an audit, says Goldstein, the IRS is going to examine the source of the money that supports the mortgage interest.

Goldstein says that there could be legitimate reasons taxpayers are reporting mortgage interest that appears too large for their income. If, for instance, you received help from your family -- say an $8,000 check annually from your parents, keep documentation of that gift.


Deduct correctly

You could be paying lots of mortgage interest not just from buying with an exotic mortgage, because you took on a big "cash-out" refinance or equity loan.

"Many people are under the mistaken impression that any interest from any loan on their home is deductible, but it is not," says William Lazor, partner with the accounting firm Kronick Kalada Berdy, Kingston, Pa.


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