Discussion:Excess mortgage interest scenario

MFJ filers. Home A was the primary residence in prior years worth more than $1M, no mortgage. Filer takes $1M home equity line on Home A to buy a lot and build a new primary residence, Home B. Filer also takes a $1.1M construction loan to build the new Home B. Fast forward to 2009. Home B now has a mortgage of $1,070,000 converted from the original construction loan. Home B FMV is considered as $1,250,000. Home A still has a $1M home equity line balance. Home B FMV is considered as $1,150,000. (I know - $2M for a home maybe worth $1.25M now? But that is not my concern at the moment.)

Here is a summary to show my interpretation as related to 26 USC 163:

Home A - 2nd home 9former primary residence) Qualified Residence: TRUE; Type of loan: Home Equity; Qualified Residence Interest: TRUE; Acquisition indebtedness: TRUE; Home Equity indebtedness: FALSE; Amount of indebtedness: 1,000,000; Amount of interest paid: 30,000

Home B - New Primary residence Qualified Residence: TRUE; Type of loan: Mortgage; Qualified Residence Interest: TRUE; Acquisition indebtedness: TRUE; Home Equity indebtedness: FALSE; Amount of indebtedness: 1,070,000; Amount of interest paid: 70,000

I think Home A debt meets the definition of "acquisition indebtedness" because it was used "in acquiring, constructing, or substanitally improving any qualified residence.

At first I thought I could consider only the Home B mortgage of $1,070,00 below the $1.1M limit and take the Sch A deduction of $70K for that debt, not considering Home A debt which exceeds the $1.1M limit.

Further consideration led me to conclude that I must use both debts in the calculation of deductible home mortgage interest per Pub 936 Table 1 Worksheet. That result is: $1,100,000 / $2,070,000 = 53.1% x $100,000 total interest = $53,100 deductible home mortgage interest. Obviously much less advantageous to the filers.

I then considered: Reg Sec 1.163-10T(o)(5) Election to treat debt as not secured by a qualified residence— [[1]]

I thought this election could be used to exclude the Home A debt from consideration as qualified residence interest and therefore allow the deduction for $70k of interest paid on the Home B debt. However, all of Home A debt was used to acquire Home B and not for another purpose either deductible or nondeductible. Tracing the debt leads nowhere else. I reluctantly conclude that substance over form renders the election invalid in this case.

Is my reasoning accurate and sound? Am I missing a justification that allows $70k of deductible mortgage interest for Home B debt instead of only $53k for the combined Home A debt and Home B debt? Thank you.