How much of my home mortgage interest can I deduct?

Generally, you can deduct all interest on home mortgages for up to two homes, although the 2% reduction does apply. However, you have to look more closely at the mortgage to determine if there is any other limit that may come into play. For this purpose, mortgages break down into three categories (it is all a bit more complicated than presented here, and if you find these to be applicable to your situation, you should consider seeking a tax advisor):

1. Grandfather debt - in this context, grandfather debt refers to any mortgage on your primary residence or a second house which was taken out on or before October 13, 1987. All interest expenses for grandfather debt is fully deductible, although it may limit your deductions related to the other two types of mortgage loans, discussed below.

2. Home Acquisition Loan - this refers to a mortgage taken out after October 13, 1987 and which was used to buy, build or improve your primary residence or a second home. You can generally deduct interest related to such a loan if the loan is for less than $1,000,000 (or $500,000 if you are married and filing separately). If the loan is for more than this, you should use IRS Publication 936 to determine how much of your interest expense you can claim as a deduction.

3. Home Equity Loan - this refers to a mortgage taken out after October 13, 1987 and which was used for anything other than to buy, build or improve your primary residence or a second home. You can generally deduct interest related to such a loan if the loan is for less than whichever of these amounts is smaller: (i) $100,000 (or $50,000 if you are married and filing separately); or (ii) the fair market value of your principal residence and any second home, less the amount of any home acquisition debt or grandfather debt.

Finally, just to confuse things further, if you have grandfather debt, it lowers the limit of how much interest you can deduct for a home acquisition or home equity loan. If you have grandfather debt, you have to subtract the amount of the remaining principal from the limits for home acquisition or home equity loans. For example, if you have $100,000 of grandfather debt, your limit for home acquisition loan deductions goes from $1,000,000 to $900,000 (or to $400,000 if you are married and filing separately).