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Mortgage interest is deductible in two main ways, but primarily limited to your primary residence and qualifying second home. One is acquisition indebtedness and the other is home equity indebtedness. Firstly we will understand what these two terms mean.

Acquisition Indebt ness is the amount of debt you incur when you first purchase your home, minus the amount of principal you have paid down. This amount currently is limited to the first $1 million of your mortgage balance(s). The only way that acquisition indebt ness can increase is if you have or will be completing qualified home improvements. If you did improvements within the last two years, you can still refinance and count that amount as part of your acquisition indebt ness.

Home Equity Indebtedness is the amount of your mortgage(s) exceeding your acquisition indebt ness. Currently home equity indebtedness is limited to $100,000.

The problem is that if you did cash out refinance of more than $100,000, you cannot deduct the interest on the amount beyond $100,000. This is because of the Home equity indebt ness limitation. Most people believe that they can take out $100,000 beyond the amount of their original mortgage, which is incorrect.

Well, in this case, your acquisition indebtedness is $100,000, your allowable home equity indebtedness is $100,000, so you can only deduct interest off the first $200,000. The other $100,000 is non-deductible in this case.

There are ways to legally exceed these limitations. The Alternative Minimum Tax (AMT) limitations, you may not be able to fully deduct your mortgage interest anyways.