Interest is an amount you pay for the use of borrowed money. To deduct interest you paid on a debt you must be legally liable for the debt. Additionally, you must be able to itemize your deductions.

If you prepay interest, you must allocate the interest over the tax years to which it applies. You may deduct in each year only the interest that applies to that year.

The types of interest you can deduct on Schedule A of Form 1040 are investment interest, certain home mortgage interest, and points in some cases. For information on points, refer to Topic 504.

Home mortgage interest is interest you pay on a loan secured by your main home or a second home. The loan may be a mortgage to buy your home, a second mortgage, or a home equity loan or line of credit.

Your main home is where you spend most of your time. It can be a house, cooperative apartment, condominium, house trailer or houseboat that has sleeping, cooking and toilet facilities.

A second home can include any other residence you own, whether or not you use it as a home. But if you rent it to others, you must also use it for personal purposes during the year for more than the greater of 14 days or 10 percent of the number of days you rent it.

Home Mortgage interest and points are generally reported to you on Form 1098, Mortgage Interest Statement by the financial institution to which you made the payments.

If all of your mortgages fit into one or more of the following three categories at all times during the year, you can deduct all of the interest on these mortgages.

1. Mortgages you took out on or before October 13, 1987, called grandfathered debt,
2. Mortgages you took out after October 13, 1987, to buy, build, or improve your home, but only if these mortgages plus any grandfathered debt totaled $1 million or less throughout 1997. The limit is $500,000 if you are married filing separately;
3. Mortgages you took out after October 13, 1987, other than to buy, build, or improve your home (called home equity debt), but only if these mortgages totaled $100,000 or less throughout 1997 and all mortgages on the home totaled no more than its fair market value. The limit is $50,000 if you are married filing separately.

If one or more of your mortgages does not fit into any of these categories, get Publication 936, Home Mortgage Interest Deduction, to figure the amount of interest you can deduct.

You may be able to take a credit against your federal income tax if you were issued a mortgage credit certificate by a state or local government. Use Form 8396, Mortgage Interest Credit, to figure the amount. Individuals who claim the credit must reduce their mortgage interest deduction by the amount of the credit. Items you cannot deduct as interest include points, if you are a seller, service charges, credit investigation fees, interest relating to tax-exempt income, and interest to purchase or carry tax-exempt securities.

You cannot deduct personal interest. Personal interest includes interest paid on car loans, credit cards, and personal loans such as student loans.

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