Discussion:Mortgage interest deduction on equity loan
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Discussion Forum Index --> Tax Questions --> Mortgage interest deduction on equity loan
| 20 July 2006 | |
| If someone takes out equity on a personal residence, uses the money as a down payment on a new home that will be his new personal residence, then turns the prior personal home into the rental, is the interest on that equity loan just considered nondeductible interest since the loan is not secured by the new personal residence? That is my understanding after reading the requirements to deduct the interest as home mortgage interest. And since the equity was not used for the rental, then it is not deductible there either. | |
Michaelstar (talk|edits) said: | 20 July 2006 |
| You are 100% correct in your conclusion to this example if it is to be structured as such. Hope the t/p did not take out allot. If he did, I might suggest that he take out an equity loan (or 2nd) on the new personal residence, pay off the equity loan on the rental and then they will have put themselves in a position to start deducting the interest as mortgage interest on their primary residence. If this is done, very soon after buying the new residence, I would take the position that it would be acquisition debt and not equity debt so as not to have an alt min adjustment on the interest deduction. Hope the suggestion helps out your client. | |
Death&Taxes (talk|edits) said: | 20 July 2006 |
| I agree totally, Michael, but I have to wonder how many have ever seen an IRS proceeds tracing audit? I prepare 400-500 mostly upper middle class white collar returns a year and never have. Or how many have questioned new clients about their 1098 forms to see if they could have possibly taken out too much equity in the past in refinancing? Way back when these rules went into effect, a multi-millionaire client, now dead, used 700,000K+ on an equity loan to build a new residence. I explained the rules to him; he held up the 1098 and said 'but this is what the government got.' Only when I did some 28% math for him, which gives some idea how long ago it was, and then did the potential penalties on same, did he change course. | |
| 20 July 2006 | |
| D&T,
I always wondered this...how many on the board have seen an IRS proceeds tracing audit? I am well aware of the interest tracing rules, but the only time I saw an audit was 1 time during my 5 year career at one of the Big 4 accounting firms. Not that I am advocating ignoring these rules, but just more curious on how hard a line other CPA's take with their clients regarding this. | |
Michaelstar (talk|edits) said: | 20 July 2006 |
| I have yet to have an IRS audit under the interest tracing rules - have been in public accounting since 1983. I do hold the line and follow the rules as best that I can. I always as the question and I request a copy of every closing escrow on every refinance. Have read these interest tracing rules many times over. As I see it, it is not a question of it the IRS audits the rules, it is my job as a CPA to prepare the clients returns to the best of my abilities and that is what my clients expect out of me. To not follow the rules and take deductions that are invalid it against my belief system and I certainly do not want to sit across the table from a client and explain an audit adjustment becuase I (not the client because you know they have no idea what the interest tracing rules are all about) failed to know and follow the rules. Also, there is no way I am going to accept the liability on something so basic. I have actually had the IRS change a return I prepared and remove the equity interest adjustment from alt min and issue the client a refund - go figure! | |
| 20 July 2006 | |
| We did get a notice ONCE where client had over $100,000 of mortgage interest and a portion was disallowed due to over $1,100,000 personal residence debt. Audits are rare for ALL areas except for CP 2000 matching errors. They probably field audit less than 1%. | |
| 20 July 2006 | |
| Michaelstar,
I fully agree with you - I try to hold the line and follow the rules to the best of my ability. As you said, it is our duty as a CPA from an ethical standpoint, and we are required to do so under Circular 530. I was just curious to see if anyone had experience in it. | |
Michaelstar (talk|edits) said: | 20 July 2006 |
| I am curious as well - you have a very good question. We always here "well my friends CPA does not make them follow the rules like that" but that line has never made me go over to the dark side........ | |
| 20 July 2006 | |
| While on this subject, any ideas on this situation?
Client buys commercial rental real estate for 1 million, and for the example's sake, finances all of the purchase. He then refinances a few years later (California property) for 2 million, and invests the extra 1 million in the stock market. Okay. 1/2 the interest on the new loan traces to the commercial real estate, 1/2 traces to investment interest expense, which carries forward because he is in growth stocks and there is no portfolio income to apply it against. Then the 1 million stock portfolio becomes essentially worthless (the internet stock crash). Now here is the problem. The investment interest on the 1 million continues to trace to investment interest expense. Now if he would have sold the stock for a gain, he could have elected to use the investment interest expense carryforward to offset this gain. However, when he sells the real estate, HE WILL NOT BE ABLE TO APPLY THIS INVESTMENT INTEREST EXPENSE CARRYFORWARD AGAINST THE GAIN ON THE SALE OF THE REAL ESTATE BECAUSE IT IS A PASSIVE ACTIVITY! Thankfully, he will be able to offset the capital gain on the real estate with the 1 million capital loss carryforward from the stock loss. I am afraid that I am correct here. Any suggestions as to how to take advantage of this what is becoming HUGE investment interest expense carryover? | |
Death&Taxes (talk|edits) said: | 20 July 2006 |
| Can we assume there are proceeds over and above the 2 million in debt that was paid off at settlement? If so, investments in bonds can recover that investment interest, but your client has to be patient. Off the top of my head, I can think of nothing else. The discussion here has been most interesting, and we did not even touch on the other bugaboo, the AMT and equity interest. | |
| 20 July 2006 | |
| I have asked a few tax professionals about AMT and equity interest who didn't even know what I was talking about. They have not been adding the applicable home equity interest expense back into the AMT equation.
If anyone who reads this is not aware of it, you should become aware . . . | |
Mark Eason (talk|edits) said: | 21 July 2006 |
| I have learned a lot from this question and good timing with a client. QUESTION: A couple owns a house that they rent part of the house to their S Corp as a Bed & Breakfeast (about 6/7 is rented). The remainder of the house is their primary residence. The couple wants to retire from being B & B operators, and they want to sale the house. The housing market and B & B sales have gone soft but are still looking at a $100,000 gain from original purchase price of house. They are thinking now about ceasing B & B operations and converting the whole house as primary residence and then sale 2 plus years later to get the exclusion on the gain (I told them about depr recapture). Assume the loan on the house is all acquisition debt. House was purchased for B & B purpose with them living in part of it (not a conversion to B & B). What happens to the interest that I have been putting on Sch E for rental interest if they convert the B & B portion to primary residence use? | |
| 21 July 2006 | |
| I must be missing something here, Mark. It seems slam dunky to me. Just start deducting all of the interest on Sch A as 100% acquisition debt. Without thinking too much about it, I would say you are converting rental property to personal residence property.
Say I buy a rental property, and finance the purchase with a mortgage. I would write that interest off on Schedule E. But then a few years go by, and I decide to move into the house, and make it my primary residence. Are you suggesting that I would not be able to write off the interest on Schedule A now? From your question I am inferring that this is what you are suggesting. I have done this with a few clients, and now you have me wondering. Let me know what you think. Thanks. | |
Mark Eason (talk|edits) said: | 24 July 2006 |
| Thanks Deaner. Your answer is correct. I went to RIA and researched under "reallocation" and "recharacterization". Looks like Sch E interest is reallocated to Sch A. However, the part of the original loan that went for furniture, fictures and kitchen glassware would be reallocated to personal interest. (They bought the B & B already furnished.) | |
