I will be paying interest for my mortgage loan for a new residence bought in a foreign country. The loan was obtained in the same foreign country. I will be paying the interest and principal from my US income as I don't have any income in that foreign country. Can I itemize the mortgage interest in my US tax returns?

In my opinion, yes. There is NO requirement that the second home be inside the United States for the mortgage interest to be deductible.

However, once they become aware of the deduction, the IRS MAY require that you withhold 30% of the payment to the foreign bank and forward that money to them so that the bank is forced to submit the profits on this transaction to the IRS for taxation.

It is MOST LIKELY that the bank has NO INTENTION of submitting the transaction to the IRS for a tax assessment, and the bank would probably strenuously object to you withholding the money, even if the IRS specifically required it as a matter of U.S. tax law. In that case, you would have to pay the 30% out of YOUR pocket.

Thusly, you are in an interesting quandary. You can claim the deduction and identify the bank to whom you are making the mortgage payments; this is REQUIRED if the mortgage interest is NOT tracked and reported to the IRS on Form 1098. Hopefully, the IRS will accept the deduction without requiring the withholding. However, if the IRS does require the withholding, that will most likely make the deduction worthless if you must make the payment from your own funds.

I have had a number of clienst deduct such mortgage interest paid to foreign banks over the past several years. To date, NONE have been required to make the 30% withholding, but that does NOT mean the IRS will not require it of you.

Your choice on how to proceed.

Hi AtlantaTaxExpert,

Thanks for the response. I was told by my friend that the interest must be paid directly to the foreign lender from my US bank account and not through a bank account in the foreign country (I plan to transfer money from US bank to a foreign savings account and issue a check from that account to the lender towards mortgage payments. They don't accept direct US checks). Is there any restriction like that? BTW, I report interest income from my foreign savings bank account in my US tax return - I don't see why not report mortgage interest that I pay off that account. Of course, I understand that I have to be mindful of the 30% withholding issue you mentioned earlier.

Thanks in advance

There are likely reporting requirements to the IRS if the check originates from the U.S. which is why the bank refuses to accept checks drawn on a U.S. bank. Same logic on direct transfers from a U.S. bank to the foreign bank.

And don't forget to file Form 1042 to report the payment of the interest expense.