The Deductibility of Mortgage Interest
Mar 01, 2015 07:20PM ● Published by MED Magazine
By David Kelly, Megastar Financial, " America's Most Trusted Mortgage Company"
Contrary to popular belief, mortgage interest is not always tax deductible. Here’s the inside scoop:
1. Is your Home a “Qualified Residence?
Mortgage Interest is only deductible if the mortgage is attached to a “Qualified Residence”. Tax Payers can generally deduct the mortgage interest on two qualified homes:
• One Primary Residence and,
• One Vacation Home
2. Is Your Mortgage Classified as “Acquisition Indebtedness” or “Home Equity Indebtedness”?
Your mortgage or home equity line of credit is considered “acquisition indebtedness” if it was used to buy, build or improve a qualified residence.
On the other hand, a
mortgage or home equity line of credit that is used for any other purpose is considered “home equity indebtedness”. Generally, you can deduct the interest on mortgage balances up to $1,000,000 of Acquisition Indebtedness, and $100,000 of Home Equity Indebtedness.
Here are two examples:
• Jane buys her $500,000 primary residence using a $400,000 mortgage. Jane would be able to deduct the interest on $400,000 mortgage as acquisition indebtedness because, (1) the mortgage was used to buy a qualified residence; and, (2) the mortgage falls within the $1,000,000 limit.
• Janice buys her $500,000 primary residence with cash. A year later, Janice does a cash-out refinance and puts a $400,000 mortgage on the home. The funds are not used for home improvements. Janice could deduct the interest on the first $100,000 of this mortgage as “home equity indebtedness”. However, the interest on the remaining $300,000 balance would NOT be tax deductible because it exceeds the $100,000 limitation on home equity.
3. Are You Subject to the AMT?
Approximately six million American tax payers are subject to the Alternative Minimum Tax (AMT). These tax payers can still deduct the interest on mortgages and home equity lines of credit that are classified as “acquisition indebtedness”. However, tax payers who are subject to the AMT are NOT allowed to deduct the interest on mortgages and home equity lines of credit that are classified as “home equity indebtedness”.
Three Pitfalls to Avoid
As you can see, it’s very important to structure your mortgage in a way where it can be classified as “acquisition indebtedness”! Here are three common mistakes that many people make when choosing a mortgage strategy and deducting their mortgage interest:
• Pulling cash out of a primary residence to buy a vacation home, and then illegally deducting the interest on the cash-out mortgage (in these cases, it’ often better to place a mortgage on the vacation home itself so that it can be classified as “acquisition indebtedness”).
• Paying cash for a home, taking out a mortgage later on, and then illegally deducting the interest on the cash-out mortgage.
• Illegally deducting the interest on mortgage balances that are classified as home equity indebtedness.
Distinction Between a Qualified Residence and an Investment Property
Everything mentioned above pertains to a mortgage transaction involving a primary home or vacation home that is elected as a “qualified residence” for tax purposes. If your transaction involved an investment property, see IRS Publication 527.
PLEASE NOTE: THIS ARTICLE AND OVERVIEW IS PROVIDED FOR INFORMATIONAL PURPOSES ONLY AND DOES NOT CONSTITUTE LEGAL, TAX, OR FINANCIAL ADVICE. PLEASE CONSULT WITH A QUALIFIED TAX ADVISOR FOR SPECIFIC ADVICE PERTAINING TO YORU SITUATION. FOR MORE INFORMATION ON ANY OF THESE ITEMS, PLEASE REFERENCE IRS PUBLICATION 936.