Discussion:Investment Interest Expense?

IMO, it depends on what the client intends to use the land for, could well be investment interest expense, IF the lot is held as an investment.

Investment interest expense does not offset passive income, it offsets investment income, interest, dividends If your client does not have investment income, and Sec. 266 applies, you may want to make that election.

Interest paid on a second home is mortgage interest.

Does this sound reasonable? Anyone else have additional info?

(d) Limitation on investment interest

     (1) In general
       In the case of a taxpayer other than a corporation, the amount
       allowed as a deduction under this chapter for investment interest
       for any taxable year shall not exceed the net investment income
       of the taxpayer for the taxable year.
     (2) Carryforward of disallowed interest
       The amount not allowed as a deduction for any taxable year by
       reason of paragraph (1) shall be treated as investment interest
       paid or accrued by the taxpayer in the succeeding taxable year.
     (3) Investment interest
       For purposes of this subsection -
       (A) In general
         The term investment interest means any interest allowable
         as a deduction under this chapter (determined without regard to
         paragraph (1)) which is paid or accrued on indebtedness
         properly allocable to property held for investment.
       (B) Exceptions
         The term investment interest shall not include -
           (i) any qualified residence interest (as defined in
             subsection (h)(3)), or
           (ii) any interest which is taken into account under section
             469 in computing income or loss from a passive activity of
             the taxpayer.

         The term investment interest shall not include -
           (i) any qualified residence interest (as defined in
             subsection (h)(3)), or
           (ii) any interest which is taken into account under section
             469 in computing income or loss from a passive activity of
             the taxpayer.

SO.....Why not treat this situation as investment interest. The land was bought for investment purposes, it's not a qualified residence, and it's not a passive activity.

1. This is vacant land, with an intent to build a home on it. Thus, it is not investment interest. There is no construction going on right now. From Publication 936 I see that a home has to be under construction in order for it to qualify as a "qualfied home" for the mortgage interest deduction. Since the lot is vacant and no construction took place in 2007, it cannot be considered a "qualified home" and couldn't even be considered a second home for mortgage interest consideration.

2. If the funds used for the loan is truly a home equity loan secured by the first and second qualifed homes, then interest is limited based on the $100k home equity loan limit, since it is going to be used to build a home. In this case, would only $100,000 of the $1.8 million loan be used in determining the mortgage interest deduction?

Sorry - the answer is probably right in front of my nose. I'm just having trouble making sense out of these 2 issues and how they work together. Thanks for patience!

Don't you wish they would have asked you before they started? Let the banker do the tax return!

I appreciate all the help I get from this forum, by the way. Thanks again everyone for all the great insight and advice you give.

Can anyone point me to a cite on EZTAX's comment above that:

"In order for interest to be mortgage interest one of the requirements is that the loan is secured by the home. In other words, the home needs to have a lien on it. If a home is purchased with money borrowed against another residence then that cannot be deductible as mortgage interest."

The reason I ask is that I have some CPE materials that say the following:

"Exception to tracing rules -Category 1 (qualified residence interest) includes home-equity loans on a principal or second residence. For the home-equity loan to be deductible as qualified residence interest the loan must be specifically secured by the primary or secondary residence.*

• cites Temp. regs 1.163-10T(j)(1) and 1.163-10T(o)(1)

This makes it sound to me that the HELOC dollars, which are secured by the primary residence, but used to purchase the secondary residence, qualifies as qualified residence interest and is deductible on Schedule A (assuming total debt is under $1 Million).

I have read through the Temp regs cited above and couldn't really find a definitive answer.

Thanks in advance for your help.

http://www.taxalmanac.org/index.php/Discussion:Home_Acquisition_Debt_vs_Home_Equity_Debt

Here is what 163(h)(3)(B) actually says:

(B) Acquisition indebtedness.

(i) In general. The term “acquisition indebtedness” means any indebtedness which—

(I) is incurred in acquiring, constructing, or substantially improving any qualified residence of the taxpayer, and

(II) is secured by such residence.

Stevo, your materials are correct, a home-equity loan may be secured by either the primary or the secondary home and thereby qualify as qualified residential interest. But the issue is not just that the debt be "home equity debt" There are two limits and two definitions you must be aware of. First, the interest on "Home Acquisition Debt" (HAD) is deductible on HAD of up to $1,000,000. Secondly, the interest on "Home Equity Debt" (HED) is deductible in up to $100,000 of principal. The HELOC that is secured by the primary residence and used to purchase the second residence is HED, not HAD. Therefore, your client will only be able to deduct 40% of the interest on the HELOC ($100k/$250k).