Just then the envelope with the April rent bill appeared under the door.

Typical taxpayers such as this married couple use the standard deduction instead of itemizing. The election to itemize is appropriate when total itemized deductions exceed the standard deduction ($10,000 for joint filers and $5,000 for single in 2005).

Obtaining a home mortgage or home equity debt is one way to increase your itemized deductions. Homeowners clearly benefit more from the allowance of itemized deductions than those who rent.

Let’s identify what can be deducted as home mortgage interest and the limits on deductible interest. Generally, any interest that you pay on a loan secured by your qualified home (subject to limitations) can be part of your itemized deductions. Homeowners can claim an itemized deduction for interest on:

1. up to $1,000,000 of mortgage debt used to (a) buy, build or improve their qualified home, or (b) replace a previous mortgage used for one of those purposes; and
2. up to $100,000 of home equity debt secured by their qualified home.

A qualified home includes (1) the taxpayer’s principal residence and (2) one other residence. A home includes a house, condominium, cooperative, time-share, mobile home, house trailer, boat, or similar residence with sleeping, cooking and toilet facilities.

1. Principal Residence. You can have only one principal residence at any time. This would be the home where you live most of the time.
   
   
2. Second home. Of course, you can have more than one second home, but only one can be treated as your qualified second home during any year.

   You don’t have to use this home the whole year. However, if you hold this property out for rental, you also must use it as your home for more than 14 days or more than 10% of the number of days during the year that the home is rented out, whichever is longer. (If you don’t use this property as your home long enough it will lose the characteristics of a qualified home and will be treated exclusively as a rental property). This rule is also applied to the rental of a time-share.

   You can change which home is treated as your "second home" from one year to another.

   Only in the following three situations, however, can you change the home you treat as your second home during any one year:

   • if you purchased a new home;
   • if your original principal residence no longer qualifies as your main home; or
   • if your second home is sold or becomes your main home.

If your home was destroyed by an "act of God" or by any other casualty, you can continue deducting interest that you pay on your mortgage if you rebuild your home or sell the land on which the home was located within a reasonable period of time.

If you are married filling a joint return, the qualified home can be owned jointly or by either spouse. If you file separate returns and own more than one home, you can each treat only one home as a qualified residence. However, if both spouses agree in writing, then one spouse can take both the principal residence and the second home into account.

It is also important to know about other special items that can be included as home mortgage interest. These items are:

• Late Payment Charge on mortgage payment, if it wasn’t for a specific service in connection with your mortgage.
  
  
• Mortgage Prepayment Penalty, if you pay off your mortgage early and the penalty is not for a specific service performed.
  
  
• Principal Residence Loan Origination Fee (usually called Points). Each point equals 1% of the amount borrowed. The general rule is that for each one point loan fee paid, the lender should reduce the loan’s interest rate by 1/4 to 1/8 percent. That’s why a lot of homebuyers prefer to pay a one- or two-point loan fee to reduce their loan’s interest rate and deduct their loan fee in the tax year of their purchase (generally, it takes about 5-7 years in order to start benefiting from paying points up-front). However, in order to deduct the full amount of points in the year they are paid, your loan must be used to buy or build your main home. Otherwise, the points are considered to be prepaid interest and must be deducted over the life of the mortgage.
  
  
• Second Home Points. Note that points on your second home mortgage cannot be fully deducted in the year paid. As a general rule, Form 1098 (Mortgage Interest Statement) will include only points that are fully deductible. However, certain points not included on the form but shown on your Settlement Statement may also be deductible.
  
  
• Refinancing Points. Generally, the points you paid to refinance your mortgage are not fully deducted in the year you paid them. Instead, they are deducted (amortized) over the life of your mortgage. If part of the refinanced mortgage proceeds is used to improve your main home, then the portion of the points related to improvements is deductible. However, if you refinance your mortgage again (e.g., to take advantage of low interest rates) then the unamortized points from your prior refinance become fully deductible in the year of your subsequent refinance. For example, if you have $500 of unamortized points remaining from your refinance in 2003, and this year you refinance to pay off your old mortgage, the full $500 is deductible on your 2005 tax return.
  
  

• If you bought your home within 90 days before or after taking out your mortgage;
• You build your home and take out the mortgage before the work is completed;
• You build your home and take out the mortgage within 90 days after the work has been completed.

If the proceeds were used for any other purpose, it is considered to be "personal interest", which is not deductible. Also, please remember that if the proceeds of a mortgage or home equity debt were used to buy securities or certificates that produce tax-free income, then the interest on that mortgage is not deductible.

Example:

You bought a home in 1999 for $150,000. This year you decided to take out a $100,000 home equity loan to pay off your high interest rate credit cards and a car loan. The fair market value of your home is $200,000 and the balance owed on your mortgage is $110,000. Interest on only $90,000 [$200,000 – $110,000] out of the total $100,000 home equity loan can be deducted.

This factor may seem to be a disadvantage, but since interest paid on credit cards and a car loan is considered personal interest (and nondeductible), you will still be in a "win" situation.

Another problem arises for those homeowners who are subject to AMT (Alternative Minimum Tax). For the purposes of calculating AMT, there is a rule that disallows the deduction of home equity loan interest if the proceeds were used for purposes other than to buy, build, or improve your property.

To find out ways to deal with AMT, please refer to Stay Out of My Yard by Joe Tancer.

Moreover, you are building up equity in your home. Rent payments, on the other hand, offer no tax savings and essentially are money down the drain.

Now you are familiar with the most important tax savings opportunities available. While there are some limitations, tax benefit is a great advantage to home ownership.

Just imagine, tax savings and no more rent bills under the door!