Discussion:Mortgage interest deduction above $1M?
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Discussion Forum Index --> Tax Questions --> Mortgage interest deduction above $1M?
| 30 November 2006 | |
| Question: To acquire my primary residence, I took out a primary mortgage of $1.3M and a second mortgage (Home Equity Loan) of $300,000 (both mortgages taken out concurrently this year). I understand that the interest deduction for the primary mortgage is limited to $1M. But, the IRS website makes it seem like the interest on the first $100,000 of any second mortgage, be it HEL or HELOC, is also tax deductible (for a total of $1.1M in my situation). Am I reading this correctly? Thanks in advance for your help. | |
| 30 November 2006 | |
| A strict reading of Code Section 163(h)(3)(C)(i) would indicate that the HELOC does not qualify as home equity debt because it is in fact home acquisition debt (see "other than acquisition indebtedness"). Therefore your interest deduction would be limited to the interest on the $1,000,000 first mortgage. However, 163(h)(3)(B)(ii) limits acquisition debt to $1,000,000. The question is, does the limit on 163(h)(3)(B)(ii) mean that acquisition debt above the limit is not treated as acquisition debt, and therefore, the HELOC would be valid home equity indebtedness??? Or, does it remain as home acquisition debt above the limit and hence nondeductible?? My take is that the HELOC is nondeductible acquisition debt and cannot be considered home equity debt due to the "other than acquisition indebtedness" wording.
RILEY? WES?
163(h)(3)(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. Such term also includes any indebtedness secured by such residence resulting from the refinancing of indebtedness meeting the requirements of the preceding sentence (or this sentence); but only to the extent the amount of the indebtedness resulting from such refinancing does not exceed the amount of the refinanced indebtedness. (ii) $1,000,000 Limitation The aggregate amount treated as acquisition indebtedness for any period shall not exceed $1,000,000 ($500,000 in the case of a married individual filing a separate return).
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| 30 November 2006 | |
| JDuganCPA, the Tax Court agrees with you. In Peter S. Pau, et ux., TC Memo 1997-43, the Tax Court held that the taxpayers must demonstrate that a portion of their debt was not incurred in acquiring, constructing or substantially improving their residence in order to claim a home equity indebtedness interest deduction. | |
Michaelstar (talk|edits) said: | 30 November 2006 |
| Douhan - based on your explanation - you have $1.6m in acquisition indebtness. You are limited to only $1M as you have found out - the interest expense on the additional $600k is unfortunately non deductible. As JD is pointing out - non of that $600k can be considered home equity indebtness because you incurred both the first and the second in acquiring the home. You can not even now take out a third for $100k and pay down the second with that $100k and consider that home equity indebtness because you would only be swapping debt. | |
| 30 November 2006 | |
| But you can pay off some of the loans through other funds (y'all gotta be making a good sized bonus to have that big a mortgage), and then refinance sometime later for an extra $100K if you really need the spare cash at a later point.
I think the IRS limit's a good idea, but I think it should be indexed to inflation. I abhor the way they come up with a "big" number and just let it sit forever. It invariably gets eroded away by inflation. The AMT threashhold was once just such a "big" number. | |
| 30 November 2006 | |
| The Tax Court has apparently taken position that the home equity indebtedness is debt other than home acquisition indebtedness. This position is supported in the statutory language. However, the statute also provides that home acquisition indebtedness used to acquire a home is not technically home acquisition indebtedness when the total home acquisition debt exceeds $1 million. I think the Court may have issued a bad ruling. | |
| 30 November 2006 | |
| Thanks everyone for the replies. It seems clear from your answers that in my situation, I'm limited to the $1M total. Three more follow-up questions, if you don't mind:
1) Is Lizzit suggesting that there may be a way to write off the interest on $1.1M? For example, suppose I pay off the entire HEL ($300,000), and $200,000 on the primary mortgage. I now have a single loan on the house of $1,100,000. I open an new HELOC for $100,000, and use the line to pay off $100,000 of the primary mortgage. I now have two debts, a primary mortgage of $1M and a HELOC of $100,000. The interest on both would now be entirely tax deductible, because the HELOC is not acquisition debt? (If one could do this, it would seem to me that it would probably not make sense in the current interest rate environment: e.g. your primary loan is at 6% and a HELOC might be at 9%). 2) In my present situation, can I choose which interest I'd like to write off? My primary mortgage is at 6.125% and the HEL is at 7.37%. It would be most advantageous to write off all of the 7.37% loan ($300,000) and the first $700,000 of the $1.3M loan, rather than $1M of the $1.3M loan. 3) If #2 is possible, are there online calculators which allow me to figure out the amount? The reason why I ask is because it seems to get slightly complicated. It would seem like an easy calculation for the interest deduction, but I think it is not. On day one of the loan, I'd be deducting the interest on $700,000 on the first and $300,000 on the second. However, on December 31 2006, the balance of the second may be $291,000, for example. Therefore, at that point, I should be deducting the interest on $709,000 of the primary mortgage and the interest on $291,000 of the second. Seems really complicated. | |
Michaelstar (talk|edits) said: | 30 November 2006 |
| Douhan - I already answered your ? #1 (see above) - no - not as you have explained it. #2 - Yes. But you will need to track the reduction of principle. Once acq debt principle has been paid down via your monthly payments, this acq debt can not be increased unless you acquiring, constructing, or substantially improving your qualified residence. So once you pick your $1M - you have made the choice. As for #3 - I use a Lotus spreadsheet I created for all of my clients in your circumstances which you can do in Excel very easily, and allocate each monthly payment. Under the ordering rules, personal debt will be paid down first. So on your $1.3M loan - that you propose to allocate $700k/$600k - all principle payments will be allocated against the $600k until it is paid down. So the monthly interest allocation % will change on a monthly basis as the $700k % will increase each month in relation to the overall debt because the $600k principle balance will be decreasing. | |
| 30 November 2006 | |
| Dear Michaelstar,
I plan on selling some property and paying off the entire $300,000 second loan in April 2007, leaving me with the $1.3M loan which I will pay off over 30 years. Given this scenario, would it make sense for me to forget about allocating the acquision debt between the two loans, and just write off the interest on $1M on my $1.3M first mortgage, beginning at the time when I acquired the property, July 1, 2006? Thanks again. Douhan | |
Michaelstar (talk|edits) said: | 30 November 2006 |
| Douhan, yes - that would be the easiest and the actual tax benefit you would have received taking the interest on the higher rate loan for this short a period of time would be very little. Now though back to your first mortgage. Still under the interest tracing and ordering rules, the principle on the $$ above the $1M is paid down first so I still suggest tracking this via an excel spreadsheet and keep this spreadsheet in your tax return workpapers. Once the principle amount of the loan reaches $1M then you will no longer need to keep track as your monthly statements will do that for you. If you use a professional to prep your tax returns and they also then keep track of your loan via the method I am suggesting, ask for a copy of this workpaper/spreadsheet for your files just for safe keeping. | |
| 30 November 2006 | |
| The real question is why is someone with a 1.6M mortgage doing his/her own return. Have you considered consulting a tax professional? | |
| 30 November 2006 | |
| See IRS Publication 936. Table 1 is a worksheet to figure your qualified loan limit and deductible home mortgage interest for the current year. When you work through the form, your qualified loan limit will be $1,100,000. | |
| 30 November 2006 | |
| Michaelstar,
Sorry to beat a dead horse....I was re-reading one of your responses up above "So once you pick your $1M - you have made the choice". This would imply that if I take the complicated road - allocating $700,000 from the 1st loan and $300,000 from the second, then pay off the second April 2007, I'd be left with the situation of only being able to deduct the mortgage interest from $700,000 on a $1.3M loan for the next 30 years (unless I refinance). To paraphrase Martha Stewart, "This would not be a good thing". I hope I am understanding correctly and not too dense on the subject. Thanks for your patience. Sincerely, Douhan | |
| 30 November 2006 | |
| Jdugancpa - good point. Probably time to turn things over to someone who really knows what they are doing. If I decide to do so, who is good in the Bellevue, Wa area?
Burns - so you can deduct the interest on $1.1M. Interesting.... | |
Death&Taxes (talk|edits) said: | 30 November 2006 |
| I believe Tax Tools replicates this table in its software. In the year of the Pau decision I spoke to an IRS specialist in DC. This was back when Quickfinder used to publish their telephone numbers and in my clients case it was about a first and second mortgage exceeding the limit, plus a second home mortgage[whether we could ignore the second mortgage was the question but I can't remember the answer. What I do recall was that he accepted all our facts and never mentioned the Service position in Pau. | |
| 1 December 2006 | |
| The IRS publications do not follow the Pau decision. Again, I believe that the Tax Court dropped the ball on that decision. | |
Michaelstar (talk|edits) said: | 1 December 2006 |
| Burns - I have printed out and read your site of Pub 936 and have to respectively disagree with your conclusion based on the information presented so far in this post. Under the title of home equity debt in the Pub 936 on page 9 - "In addition, debt you incurred to buy, build, or substantially improve your home, to the extent it is more than the home acquisition debt limit, may qualify as home equity debt" there are other hoops to jumb through when completing Table 1 - line 7 to see if any could apply. While it could be possible to consider up to $100k of home acquisition debt as equity debt based on what I am now reading in this pub, we would need to ask Douhan the question - what is the FMV of the home reduced by the amount of its home acquisition debt to determine if any $$ would be available to include on line 7. Yet even after reading this info in the pub, I have not yet read the Tax Court Memo 1997-43 as sited by Riley2 which makes me hesitant to want to include any part of the $1.6M as equity debt when it was in fact incurred as home acquisition indebtness. Just a note: with homes decreasing in value - if the FMV decreases - we could have $$ on line 7 one year and not the next on the same debt.
Douhan - with all that goes on in these modern times, you might not want to limit yourself to someone where you live while it may be convenient. Ask some of your other well to do friends who they use and how they feel about the service they receive - In my mind, that will provide you with a better idea as to who you might want to use in fullfilling your tax preparation needs. | |
| 1 December 2006 | |
| Douhan, I am in downtown Kirkland. I'm in the process of moving my office tomorrow, so it won't be a good time for me to talk. But if you would like to discuss it, please leave your contact information on my user page. | |
| 1 December 2006 | |
| Michaelstar,
The FMV is 2.3M minus 1.6M acquision debt = 700k equity. Does this alter your thinking? When experts disagree, it's time to admit that one is "in over one's head". My taxes have been easy up to this point, so there has been no need for expert preparation. But if I were to overlook the extra $100k in mortgage interest deduction year after year because I like doing takes myself and excluded the deduction for fear of an audit, that would be a big mistake. The problem with this situation, when experts disagree, is how does a layperson know who is going to give you the correct answer? I guess one could just shop for the CPA that tells me what I want to hear: "It's OK to deduct interest on the extra $100K". (If you are reading this, IRS, I'm just kidding.) Thanks again. Douhan | |
| 1 December 2006 | |
| Two good doctors can disagree, two good tax people can disagree, etc. A lot of time it's not a question of the correct answer, but what is the better answer given the confusion of multiple (sometimes conflicting) sources of law on the problem. | |
Michaelstar (talk|edits) said: | 1 December 2006 |
| Douhan - With the FMV being $2.3M - it does not alter my thinging of my prior post but based on the calculations required to correctly complete table 1 in pub 936 - I would now agree that you would be allowed $1.1M of debt in your situation. Based on my understanding of how debt is treated when paid down under the ordering rules, I will still stand by my statements that personal debt will be paid down first, equity second and acquisition debt third (in this example we have no investment or business debt)
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| 1 December 2006 | |
| Douhan, just to make sure, you did incur the $300,000 HELOC loan in acquiring your principal residence right (i.e., you didn't use the $300k for some other purpose subsequent to the initial closing)? I guess I'm not too familiar with these things b/c I don't understand why the lender wouldn't just loan you the entire $1.6 million at the outset, rather than lend you the additional $300k later. | |
Death&Taxes (talk|edits) said: | 1 December 2006 |
| Douhan: Assume you find a professional who will deduct the interest, the questions to ask are 1. How much do I save? 2. And if I am audited, do I have substantial arguments to avoid penalty, and 3.What would your cost be to handle the audit, in terms an hourly fee? Since the Tax Court has one case on record, it is possible that if IRS disallowed the interest, you might be best paying the tax and filing suit in District Court. Do recognize in the past IRS only received Form 1098 with interest paid, not mortgage balance. I lost a potential client two years ago when I noted that his mortgage balances exceeded the limit and had since he bought the house, yet his preparer either did not realize this or agreed to play 'audit roulette,' and he had never been questioned. What I am saying here is that the interest on the 1.1 total will still be less than that reported, so perhaps nothing will ever happen, but that is why you ask the professional the questions I suggest. btw, I agree with Michael that you are entitled to the deduction. | |
| 1 December 2006 | |
| Bengoshi - yes, the $300K is a 20-year fixed payment home equity loan (HEL) (not an accessable HELOC) and was taken out concurrently with the primary mortgage (all money was acquisition debt). I would have done it all in one loan, but the primary loan required an ultra-low LTV ratio.
Death&Taxes-Good points - I will ask these questions. I'd say it was definitely OK to lose that client - he was mad because you pointed out that he was doing something illegal - he would have signed with you only if you compromised your moral standards. I agree, perhaps nothing will happen, but it's a lot less internally stressful to sleep at night thinking that everything was probably correct from the beginning. Thanks all for your input. There's obviously a community out there that loves these questions. I'm impressed. | |
| 2 March 2009 | |
| During this discussion in November-December 2006, Riley2 felt that mortgage interest on debt used to acquire, improve, etc. a residence could only be deducted on debt up to $1,000,000. Even though the worksheet in Pub 936 mechanically calculates debt limitation of $1,100,000, he argued that the 1997 and 2000 Tax Court Memos disallowing interest on the extra $100,000 were the proper ruling authority.
After googling, I found articles arguing for the deductibility of the interest on the extra $100,000, including one in the February 2003 CPA Journal. The argument seemed to be based on an assertion that any mortgage debt used to acquire, improve, etc over $1,000,000 is not "Acquistion Debt" and by default up to $100,000 of that excess is "Home Equity Debt." Now, Lacerte's 2008 computation of deductible interest through Screen 25 detail input allows the deduction of interest on the excess up to $100,000 of debt. Have any posters here changed their opinion, and if so, why? | |
| 2 March 2009 | |
| I'm not at all sure you're characterizing Riley's position above correctly (you seem to be taking his explanation of Pau as a defense of Pau, which I don't see), but in any case, take a look at these two more recent discussions that also detail the issues with the Pau case: Mortgage Int Deductibility of $1.5m Acq Loans and Mortgage Interest $1.1m - Nature of the Loans. (For your reading pleasure while you await direct answers to your question.) | |
| 2 March 2009 | |
| Trillium - I can see that you are correct - I mistakenly attributed Michaelstar's December 1, 2006, quote "Riley2 - I thought TC Memo's come before IRS Pubs or is my ordering backwards" to Riley. Thanks for the correction and the two other discussions. Normally, my reading comprehension is pretty decent.
With regard to my comment about Lacerte's computation method, they're usually very reliable. | |
