I am a little confused regarding second home mortgage interest on foreign held mortgages. Is the mortgage interest paid on a foreign held mortgage considered a second home with no rental income deductible on US taxes?

Yes, it IS deductible.

You just have to identify to whom you are paying the interest.

I agree with ATE. Mortgage interest on a second home is deductible on schedule A as an itemized deduction, even if the second home is located outside the U.S. However, if you reside in the U.S. and the lender is a foreign person/bank, then you are required to withhold 30% tax on the interest portion of the payments, unless a lower treaty rate applies. Depending on the jurisdiction, a treaty may apply to reduce or eliminate the withholding tax. However, if you want to rely on the treaty, you need to obtain a Form W-8BEN from the foreign lender where the lender certifies that it qualifies for treaty benefits. In either case, you will need to also file Form 1042 and 1042-S reporting that you made interest payments to foreign persons.

Well said, INTL Tax

However, if you reside in the U.S. and the lender is a foreign person/bank, then you are required to withhold 30% tax on the interest portion of the payments, unless a lower treaty rate applies.

I am confused, so I am paying the principle and interest, at the same time, I need to pay 30% of interest to uncle sam?

No, you need to WITHHOLD 30% of the interest payment and send it to the U.S. government to insure the foreign bank PAYS U.S. taxes on the interest they collect.

But withholding has to be done only if the bank's income is taxable in US right. If the bank's income is in the foreign country and it has not processed the loan here, how can we withhold tax and what tax to withhold if the foreign bank is not liable for taxes in US.

The property is foreign property and so is the interest income for the bank - now how is the bank liable for taxes in US and why should we withhold taxes on such interest payments.

If the property and the bank is on foreign territory, you do NOT withhold the 30% in interest.

You withhold it only if the property is in the U.S.

IntL Tax is right. It is the residence of the debtor that governs the source and here it seems it is US source.

Second, you should think about the potential for a foreign exchange gain when you repay the foreign loan.

TTE always thinks of issues we normal tax pros NEVER think about.