Tax deductions for home loans and real-estate taxes are among the best tax breaks available. You can deduct interest payments on as much as $1 million of the money you borrow to buy, build, or improve your main residence and one other home.

You can also deduct the interest on home equity loans of up to $100,000. This kind of loan is like a second mortgage, secured by your equity in your home. The amount is based on the market value of the home, less what you owe on your first mortgage or other loans on the home.

The big tax break is that you may use the loan money for just about anything and still deduct the interest. You can buy a car, finance a college education, or pay off credit cards. See IRS Publication 530, "Tax Information for First-Time Homeowners," and Publication 936, "Home Mortgage Interest Deduction."

If you use a loan secured by your home to provide money for investments or for your business, the interest may be deductible as investment interest or business interest. The deduction won't be limited by the $100,000 ceiling. But you'll want to clarify how you handle this deduction with your professional tax adviser.
The risk of home equity loans is putting up your home as
security. You can lose your home if you don't keep up with the loan payments even if you continue to pay a first mortgage.

You might also consider changing the term of your mortgage when you refinance. If you can afford to pay off your loan in 15 years rather than 30, for example, you can save a substantial amount of money. The rate on a shorter loan is often lower, but the monthly payments are higher.

SELLING YOUR HOME You also qualify for a tax break when you sell your home if it has been your primary residence for at least two of the five years before the sale and you haven't sold a different home within the past two years. In that case, if you're single, $250,000 in profit over your cost basis in the home is tax exempt. That exemption jumps to $500,000 if you're married and file a joint return.

POINTS Points are prepaid interest on a mortgage. You generally can deduct the full amount in the year you paid the points if you use the loan to buy or improve your home. Your lender shows the points you paid on Form 1098, the tax form for mortgage-interest payments. Deductions of points paid in refinancing a mortgage generally must be spread over the full term of the loan. But if you refinance again, or if you sell your home and pay off the mortgage, then you can deduct all of the remaining points at once.

Any gain above those amounts is taxed at your long-term capital gains rate if you've owned the property for more than a year. However, if you sell at a loss, it is considered a personal, not a capital loss. That means you can't use the loss to reduce taxes you may owe on other capital gains or on regular income.

Your cost basis includes not only the purchase price but amounts you spent over the years to make improvements, plus the costs of selling the home. That's one reason why it's important to keep good records while you own the property. Routine maintenance expenses, like mowing the lawn or painting the kitchen, don't count toward increasing your basis, but many other costs do. It's a good idea to get a copy of IRS Publication 523, "Selling Your Home." You can download it on the IRS website (www.irs.gov). Remember, though, that your tax basis can also be decreased if you've received certain subsidies or credits, got an insurance payment to cover losses, or took a depreciation for using part of your home as an office. Check IRS Publication 17 and talk to your tax adviser.

One complication may occur if you sold a home before 1997 and rolled any profit from the sale into your current home. You should read chapter 3 in Publication 523 and talk to your tax adviser.

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