Mortgage interest

Your biggest tax break is reflected in the house payment you make each month since, for most homeowners, the bulk of that check goes toward interest. And all that interest is deductible, unless your loan is more than $1 million. If you're the proud owner of a multimillion-dollar mortgaged mansion, the Internal Revenue Service will limit your deductible interest.

Interest tax breaks don't end with your home's first mortgage. Did you take advantage of low rates and your real estate's growing value to pull out extra cash through refinancing? Or did you decide instead to get a home equity loan or line of credit? Either way, that interest also is deductible, again within IRS guidelines.

Generally, equity debts of $100,000 or less are fully deductible. But even then, the remaining amount of your first mortgage could restrict your tax break. The IRS says you can deduct the smaller of interest on a $100,000 loan or your home's value less the amount of your existing mortgage. This could be a concern if you excessively leverage your rapidly appreciating house.

For example, you bought your home three years ago with a minimal down payment. Your mortgage balance is $95,000 and the house is now worth $110,000. Your bank says you qualify for a 125 percent loan-to-value equity line, or $42,500 ($110,000 x 125 percent = $137,000 - $95,000 left on your first mortgage). To pay for your daughter's college tuition and buy her a car to get to school, you take the bank up on the offer, thinking the interest deduction on the loan would be icing on the tax-break cake.

However, you're not going to get to deduct all that interest. Instead, your deduction is limited to interest on just $15,000 of the loan; that's the amount your home's value exceeds your first mortgage. Interest payments on the other $27,500 are not deductible, even though the equity line is secured by your home. So don't automatically assume you can deduct all interest on home equity debts.

What if your real estate circumstances are a bit brighter? Say, for instance, you're able to swing a vacation home on the lake. You're in tax luck. Mortgage interest on second homes is fully deductible. In fact, your additional property doesn't have to strictly be a house. It could be a boat or RV, as long as it has cooking, sleeping and bathroom facilities. You can even rent out your second property for part of the year and still take full advantage of the mortgage interest deduction as long as you also spend some time there.

But be careful. If you don't vacation at least 14 days at your second property, or more than 10 percent of the number of days that you do rent it out (whichever is longer), the IRS could consider the place a residential rental property and axe your interest deduction.

Points

Did you pay points to get a better rate on any of your various home loans? They offer a tax break, too. The only issue is exactly when you get to claim it.

The IRS lets you deduct points in the year you paid them if, among other things, the loan is to purchase or build your main home, payment of points is an established business practice in your area and the points were within the usual range.

A homeowner who pays points on a refinanced loan also is eligible for this tax break, but in most cases the points must be deducted over the life of the loan. So if you paid $2,000 in points to refinance your mortgage for 30 years, you can deduct $5.56 per monthly payment, or a total of $66.72 if you made 12 payments in one year on the new loan.

But if the refinancing frees up cash you then use to improve your house, you can fully deduct points on that money in the year you paid the points. The same rule applies to home equity loans or lines of credit. When the loan money is used for work on the house securing the loan, the points are deductible in the year the loan is taken out. If you use the extra cash for something else, such as buying a car, you still can deduct the points but not completely on one tax return. The points deductions must be parceled out over the equity loan's term.

And points paid on a loan secured by a second home or vacation residence, regardless of how the cash is used, must be amortized over the life of the loan.

Taxes

The other major deduction in connection with your home is property taxes.

A big part of most monthly loan payments is taxes, which go into an escrow account for payment once a year. This amount should be included on the annual statement you get from your mortgager, along with your loan interest information. These taxes will be an annual deduction as long as you own your home.

But if this is your first tax year in your house, dig out the settlement sheet you got at closing to find additional tax payment data. When the property was transferred from the seller to you, the year's tax payments were divided so that each of you paid the taxes for that portion of the tax year during which you owned the home. Your share of these taxes is fully deductible.

A word of caution: If your settlement statement shows any money you paid into an escrow account for future taxes, this amount is not deductible. You can only deduct the taxes in the year your lender actually pays them to the property tax collector.

For example, you bought your house on July 1. Your property taxes are due each Jan. 1. When you closed, the seller had already paid the year's taxes of $1,000 in full so you reimburse the seller half of his annual tax payment to cover your ownership of the property for the last six months of the year. Your $500 reimbursement to the seller is shown on your settlement documents.

The closing document also shows you pre-paid another $500 to the lender as escrow for the coming year's taxes due next Jan. 1. The $500 you reimbursed the seller at closing is deductible on this year's tax return, but the $500 held in escrow is not deductible until it is paid the next year.

One such expense is insurance. If you pay private mortgage insurance because you weren't able to come up with a large enough down payment, that's a cost you can't write off at tax time. Neither can you deduct your property insurance premiums, even though the coverage generally is required as part of the home loan and is included as a portion of your monthly payment.

Other nondeductible residential expenses include homeowner association dues, any additional principal payments you make, depreciation of your home, general closing costs and local assessments to increase the value of your neighborhood, such as construction of new sidewalks or utility connections.

What about all those repairs that seem to crop up the day after you move in? Surely they're tax deductible. Sorry. While they'll make your house much more comfortable, you're on your own here, too. UNLESS, you have a home based business, now we have lots of deductions!

But hold onto the receipts. In today's hot real estate market, some homeowners may find their property will appreciate beyond the $250,000 ($500,000 for married couples) amount the IRS will let you keep tax free when you sell. If that happens, the records of property improvements could help you establish a higher basis for your house and reduce your taxable profit.