Qualifying loans may be on either your principal or second residence.

Example: You bought your principal residence in 1995 for $200,000, taking out a $120,000 mortgage. Interest on the loan is fully deductible as qualified residence interest. In 1997, the home is worth $205,000 and you have an outstanding balance on your mortgage of $117,000. You are thinking of taking out a home equity loan. How much can you borrow and still be able to deduct all of your interest expense? Up to $88,00 ($205,000 - $117,000).

• You can deduct points you pay to refinance your mortgage in equal amounts over the life of the loan. If you have an outstanding balance on a refinanced mortgage when you sell your home or refinance again, you can deduct the remaining points in full when you pay off the old loan.
• Home buyers can deduct mortgage points paid by the seller in the year paid. You have to decrease your "adjusted tax basis" in the home by the amount of the points deducted.

The tax law gives homeowners who sell their principal residences at a profit two possible tax breaks.

Gain deferral - You don't have to pay tax on gain you realize when you sell your home as long as you replace the home within two years before or after the sale by purchasing and occupying another home of equal or greater value. When using this deferral provision, be careful in determining the adjusted basis of the home you are selling.

Very generally, this is your original cost plus certain improvements and additions you have made and minus any gains you have postponed on previous home sales, and any depreciation you may have claimed on a home office or rental of the home. Previous casualty losses can also affect your basis.

Gain exclusion - Taxpayers age 55 or older may qualify for a one-time exclusion of up to $125,000 of gain on the sale of a home. Many people have used this exclusion to eliminate tax on every dollar of gain postponed over a lifetime of selling houses. To qualify, you must have owned and used the home as your principal residence for at least three of the five years ending on the date of the sale. (Note that ownership and use don't have to coincide.)

A taxpayer may still meet the required-use rule if he or she has to move to a nursing home before his or her residence is sold. The nursing home must be a licensed facility for physically or mentally disabled persons. And the taxpayer must have lived in the residence for periods totaling at least one year during the five-year period before the sale. Then the stay in the nursing home will count as use of the principal residence. If you and your spouse own a residence jointly and file a joint tax return, only one of you has to meet the age requirement. The ownership and occupancy test may be satisfied by either spouse. However, the exclusion may be used only once per couple. So, if you and your spouse elect the exclusion and then divorce, neither of you is entitled to a new exclusion, even if you marry someone else who has not claimed the exclusion.

The tax law requirements for deducting home office expenses are tough to meet, but the tax benefits if your office qualifies can be worthwhile.

Home office expenses are deductible when the office is used exclusively and regularly: As the principal place of business for any trade or business you engage in; As a place to meet or deal with patients, clients, or customers in the normal course of your trade or business; OR

1. In connection with your trade or business, if you are using a separate structure that isn't attached to your house (for example, a detached garage). If you are an employee, the business use of the home must be for the convenience of your employer.

For tax purposes, a vacation home that you rent out is either a residence or a rental property, depending on how long you use it personally during the year. If you use the home for more than 14 days (or 10% of the number of days you rent it, if greater), it's considered a residence. Otherwise, it's rental property. When the home is a residence, certain of your deductions can't exceed the income form the property.

If you have a large mortgage on your rented-out vacation home, you may find that using it personally for enough days to qualify it as a residence generates larger deductions. You can't deduct any interest that's not allocated to the period of rental use unless the property is a qualifying residence.

• Note that, under current law, if you rent your home for less than 15 days in a year, you need not declare the rental income on your tax return. Nor are you entitled to deduct any rental expenses.