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 generally must itemize your deductions, unless the interest is on rental or business property or on a student loan.

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. However, there is an exception that applies to points paid.

The types of interest you can deduct as itemized deductions on Schedule A Form 1040 (PDF) are investment interest and home mortgage interest, including certain points. For information on points, refer to Tax Topic 504 .

You can deduct student loan interest on Form 1040 (PDF) or Form 1040A (PDF). For information on deducting student loan interest, refer to Tax Topic 456.

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, a home equity loan, or a line of credit.

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

A second home can include any other residence you own, and treat as a second home. You do not have to use the home during the year. However, if you rent it to others, you must also use it as a home during the year for more than the greater of 14 days or 10 percent of the number of days you rent it, for the interest to qualify as home mortgage interest.

Home mortgage interest and points are generally reported to you on Form 1098 (PDF), 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:

• Mortgages you took out on or before October 13, 1987, called grandfathered debt.
• 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 2002. The limit is $500,000 if you are married filing separately.
• Mortgages you took out after October 13, 1987, other than to buy, build, or improve your home, but only if these mortgages totaled $100,000 or less throughout 2002, 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, refer to Publication 936 (PDF), 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 for low income housing. Use Form 8396 (PDF), Mortgage Interest Credit, to figure the amount.

You cannot deduct personal interest. Personal interest includes interest paid on a loan to purchase a car for personal use, and credit card and installment interest incurred for personal expenses. Items you cannot deduct as interest include points (if you are a seller), service charges, credit investigation fees, and interest relating to tax–exempt income, such as interest to purchase or carry tax–exempt securities.

You may be subject to a limit (phaseout) on some of your itemized deductions including mortgage interest. For 2002, this limit applies if your adjusted gross income is more than $132,950, or $66,475 if you are married filing separately.

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