Discussion:Home Equity Loan Over 100k Used to Purchase Vacation Home :)

He pays $12,000 total interest on the HEL in 2008. Business usage (standard method) is 92%.

Presuming correct application of the vacation home rules (proration of expenses using either the standard or Tax Court method), is the interest paid on the HEL deductible on Schedule E as a business expense?

I say yes, since the loan is tracable to the business property acquisition. Of course, the deductible amount is limited to the percentage of business vs. personal usage.

Any disagreement/discussion?

If he doesn't so elect, what acquisition/home equity debt rules are involved? My take is that worse case scenario, he deducts a percentage of the 1098 interest (the 100k limit; in this case only 54%) on Sch A and eats the rest. Seems to me it would be much better allocated to Sch E, though, since that's why he did the HEL in the first place (quicker and easier to do the HEL rather than obtain new financing on the new property).

I've researched and can't find a concise citation.

The principal residence was originally purchased in 1983 for 119k; refi'd in 1993 at an appraised value of $200k; and had an appraised value of 300k at the time of the HEL. At the time the HEL was obtained the first mortgage was virtually paid off (<1k, and the HEL paid it off).

Since the entire proceeds were obviously used to purchase business property, allocation to Schedule E makes the most sense.

I hate to make the (o)(5) election since it would cut off the ability to claim the personal-use percentage of the interest on Sch A. One mitigating factor would be that if we don't elect, would he hit the >100k limitation, even if it's claimed as Sch E interest?

If this situation is a problem, he may have to try to get a first mortgage on the vacation home. It's a lot of hassle to address a rather obvious acquisition. Wouldn't the interest tracing rules clearly identify this as business interest?

Ya know, it seemed simple to me at first, but the more you dig, the cloudier the issue becomes. Of course, I don't want to do it wrong, but explaining to the client can be a pain.

(Oh, and thanks, DgR, I found it :) ).

Is the election not necessary because interest over 100k on equity is not mortgage interest so therefore no election? If the 100k of equity loan would create AMT problems then would you need to make the election to allocate all the interest to the E? Some have said that you don't need to make a formal election - just claiming the interest on a form other than A effectively makes the election? Is this true?

Thanks

But, with the election, all of the debt must be treated according to the use of the proceeds.

The RIA service recommends a positive election, but 1.163-10T(o)(5) is not specific on the point. I attach an affirmative election.

I don't attach anything if the election isn't being made and the proceeds over $100K are being treated according to the use of the proceeds.

I don't know what others are doing.

D&T - I am confused by your last post. Tracing rules negate AMT problem? Without an election, the first 100k is home equity debt so I wouuld think AMT would apply.

D&T - I am confused by your last post. Tracing rules negate AMT problem? Without an election, the first 100k is home equity debt so I wouuld think AMT would apply.

I think Smokey is correct, and since the equity line is not used for acquisition debt, it would be subject to AMT if not on the Sch E.

Thanks for the input. The fact is that the new home is a second home, but is rented out nightly on a fairly frequent basis.

The whole scene is this: TP wanted a vacation home. He bought one using a HEL on his primary residence since it was quicker and easier than doing a new mortgage on the vacation home. The entire proceeds of the HEL went toward the purchase of the vacation home. He will rent the home about 80% of the time and use it personally about 20%. The question is: what's the best way to claim the interest expense to be sure all of it's usable?

A. Elect (o)(5) and claim the business usage % (80%) interest on Schedule E; what do we do with the other 20% ? Can't use Sch A since we elected out of the property being treated as personal, right?

B. Claim the business usage % on Sch E, personal use % on Sch A, and don't worry about it? (Uneasy feeling)

C. Claim the interest on the first 100k on Sch A as second home, and the rest on Sch E as business property?

This was a very simple transaction to start with :) .

The 20% of the interest related to personal use is deducted on schedule A assuming the (o)(5) election, as long as the personal use meets the test for second home - which I think is 14 days or 10% of the days rented, whichever is higher.

On the other hand, I also believe that once the election is made to treat the debt as not secured by the residence, it cannot be bifurcated so that if the election is made, the 20% would be personal interest. At a NCPE seminar a year ago, the recommendation was that in such a situation, it would be wise to obtain two equity loans, one where the election out of home equity is made, while the smaller, 20% loan, remains home equity.

Barring that, use method C.

Others have raised the proper questions about the short term rentals, and the personal use that could lead this to being a vacation property. Those you have to answer in your own mind.

Can you point me to one that says, in effect, "the tracing rules are applied *after* the qualified residence interest rules (unless, of course, the election is made, in which case there isn't any qualified residence interest)..."?

My thought came when I read Reg. 1.163-8T(c)(6)(i) where it specifies that they are reserving this for qualified residence debt......of course, nothing was ever written, but they thought about it. Then in Reg. 1.163-10T(e) and the examples thereunder, it seems to define what would disqualify qualified residence interest and permit the use of tracing.

Based on that, and a little pushiness, I would choose to disqualify that regulation §1.163-10T from having any applicability to the current version of IRC Section 163.