Lender Security Interest

• When you are in the process of selling your home, the original mortgage you have on the home is still valid, and until you repay the entire mortgage balance in full with the proceeds of your sale, your mortgage lender retains all rights in the home. However, to claim the mortgage interest deduction, one of these rights must include a security interest that provides the lender with the right to foreclose on your home in the event you stop making your mortgage payments. In contrast, using a cash advance from a credit card to subsidize the purchase of a home doesn’t allow you to deduct the monthly interest payments you make on the card. This is because credit card companies don’t retain a security interest in the specific property you purchase with the card.
  
  

Two Homes Only

• The IRS limits your mortgage interest deduction to the loans you obtain on “qualified homes.” You can never have more than two qualified homes, one of which is always your main residence. The second qualified home can be any personal residence you choose to deduct the mortgage interest on, such as a vacation home. Therefore, if the home you are selling is not one of these two qualified homes, you cannot claim the mortgage interest during the sale. However, unlike your main residence, the IRS allows you to choose a different second qualified home each tax year.
  
  

Maximum Mortgage Balance

• The deduction has its limitations as to the amount of interest you can deduct each year. Regardless of the interest rate you pay on your mortgages, you can never deduct the interest that accrues on more than $1 million of combined principal mortgage balances on both qualified homes. To illustrate, suppose your main home has an outstanding mortgage balance of $800,000 and the home you are selling has an outstanding balance of $400,000. You can deduct all of the interest payments for your main home, but only half the interest on the second home you are selling, because $200,000 of the balance exceeds the $1 million limitation.
  
  

You Must Itemize

• One thing to always keep in mind when planning to deduct your mortgage interest is that the only way to claim it is by electing to itemize your deductions on Schedule A. This is true for tax years in which you sell your home as well as those your intention is to live in the home forever. Moreover, itemizing is only beneficial if the total of all your itemized expenses exceed the standard deduction for your filing status.