“i am considering purchasing property abroad as a 2nd home. if i take a mortgage on the property, is the interest deductible on my 1040?”---->Yes; on Sch A of 1040 line 10. Are you an owner or just on the mortgage? You have to own and be on the mortgage, plus this home has to be you or your spouse's primary or second residence. If together you and your wife own and are on the mortgage, and file jointly, then you can deduct the mortgage interest plus real estate taxes on your Sch A. The property does not have to be located in the US for you to take the deduction. If you are just on the mortgage, then you still can deduct your mortgage interest expenses on yur return; even If this property is neither your primary or second residence, you can still deduct any real estate taxes.
“also, does it effect the deductibility if the lending institution is located in the foreign country or in the US?”-----> As most people know, you can deduct the interest paid on your primary residence and a second home. Since you live and work in a foreign country and primary home in US, your foreign home would be considered your second residence. There is no requirement that the home be in the US, nor that the lender be a U.S. citizen. However, there is bad news. Interest paid by a U.S. citizen to a foreigner is subject, in most cases, to a withholding tax of 30 percent (or lesser treaty amount, if applicable. However, you’d get it back as tax refund). Since you as obligor are a U.S. citizen, you are required to withhold tax. If you do not withhold the tax, you could be liable for the tax. If you withhold the tax, the bank will probably not want to do business with you or you will quickly find yourself in default. Hence, even though you might be entitled to an interest deduction for home mortgage interest, your withholding obligation may make it impractical to obtain financing. The IRS Form W8BEN is not for you.
“i am aware of the IRS rules about rentals and having to live in the home at least 14 days of the year. i am specifically interested in whether or not i can deduct the mortgage interest payments on the home.”--->It depends on the situation;if a residence is rented for fewer than 15 days during the year, the rental period is disregarded and it is treated as a personal residence for tax purposes. The rental income us NOT taxable at all and the mort int and r/e taxes may be allowed as itemized deductions. If the residence is rented for 15 days or more and is used for personal purposes for not more than 14 days or 10% of the days rented, whichever is greater, the residence is treated as rental property. The expense then must be allocated between the personal and rental days. I fthis is the case, the rental expenses may exceeds the rental income and the resulting loss’d be deducted against other income, subject to the passive loss rules.
“also, can you point me to the IRS publication that specifically outlines the answer to this question?”---> http://www.irs.gov/pub/irs-pdf/p515.pdf