If you have refinanced, taken out a second mortgage or set up a home-equity account after Aug. 16, 1986, you'll have to do some figuring to determine how much of your mortgage-interest payments can be deducted from your 1987 tax bill.
First, add the price you paid for your home to the cost of all improvements you've made to it. Then calculate the average balance of each mortgage on your house.
Some lenders calculated the average balances for their borrowers, which makes filling out a 1987 tax return easier. But if the lender didn't do it, you have to.
According to the Internal Revenue Service, there are several ways to calculate the average balance of each mortgage on your home. If you made fixed monthly payments throughout last year, the easiest method is to take the average of the January balance and the December balance.
IRS Gives Example
The IRS offers this example: Joseph Black took out a $10,000 second mortgage on his home in 1985, and makes fixed monthly payments on it. Black looked at copies of the monthly statements from his lender, and found that the balance of the second mortgage on Jan. 1, 1987, was $9,652. On Dec. 31, it was $9,450.
Black added the first month's balance of $9,652 to the last month's balance of $9,450, divided by 2, and came up with a 1987 average balance of $9,551.
If you have a home-equity line of credit, you can divide the interest you paid for the year by the interest rate itself. If the rate varied--as most lines of credit allow--the IRS says to use the lowest rate for the year.
If the total of your average balances is less than the price you paid for your home plus improvements, you can deduct all the interest regardless of how you used the money.
Even if the average balances exceed the cost of the home plus improvements, you can still deduct all interest as long as the excess was used to pay for more improvements or for certain medical or educational expenses incurred by you, your spouse or your dependents.
If the excess was used for other items, the interest is considered "personal interest"--and you can only deduct 65% of the charges from your 1987 tax bill.
What if you had the mortgage for only part of last year? Then you'll have to follow another set of rules contained in a new IRS Form 8598, "Home Mortgage Interest."
This, all in the name of "tax simplification."