We just bought our first house and therefore I wanted to check how the interest would change our taxes. I put in some guesses on my 2008 taxact return to simulate what I would expect for my 2009 return and stumble across the alternative minimum tax.
It seems that if I put in a few thousand $ for interest paid, my tax goes down and I owe a bit less. However, when I increased the $ of interest paid, I got to the point where my refund doesn't change and noticed that while the tax goes down, my AMT goes up. It seems that my refund is therefore stuck at a certain maximum value. Is that normal? Anything that I could do to lower my taxes?
Yes, once you have reached AMT territory, that's how it works.
Use Form 6251 to determine AMT Income, and calculate the tentative minimum tax on that AMT Income.
If you have no foreign tax issues or a few other rare issues, your Tentative Minimum Tax less Regular Income tax is the line item on form 1040 labeled AMT.
So reducing regular taxable income by additional Schedule A Tax Itemized Deductions increases AMT Income, and as regualr income tax is lowered, AMT is raised.
Well, only *some* of the Schedule A deductions have this effect. Interest on home acquisition debt is typically fully deductible under AMT as well as regular tax.
See thread "AMT Difference" on June 22nd in this newsgroup for a similar discussion. You may be incorrectly telling your software that your mortgage is all equity debt, interest on which is *not* deductible under AMT.
Check to see if there is an entry on line 4 of Form 6251, if so then figure out where it is coming from.
Probably not on this item, as there is very little *you* can do to increase the amount of interest you pay on your first mortgage short of refinancing. You can always pay your January 1st 2010 payment in December (13 months of interest in one year), but that only works for one year, some year down the line you will then only get 11 months of interest deduction in one year.
Refinancing a mortgage does not convert home equity indebtedness into acquisition indebtedness.
Getting cash out on a refinance and using the cash to pay for capital improvements on a personal residence (primary or one other) would increase acquistion indebtedness.
I was considering the case of refinancing an existing acquisition-debt mortgage at a higher interest rate, for example by extending the term of the loan. Or, even if he did a cash-out refinance, while the additional debt might be equity debt, it could also result in increased interest on the acquisition-debt balance as well.
What I didn't spell out to the OP, but will try to now, is that there is little point in putting in "guesses" as to mortgage interest expense. With few exceptions (variable-rate adjustments, or the one-time "pay January in December" technique), the annual mortgage interest is a fixed, known quantity that he can either calculate himself or ask the bank to do so (by providing an amortization table).
I didn't understand why he was running through what sounded like "what-if" scenarios using his mortgage interest.
With all the "home ownership = American dream" propaganda of the last fifty years, people often forget that it's much better to pay less interest in the first place than it is to pay more interest with a partially offsetting discount on taxes. .
Yes, that's the answer to the original question, which was:
"We just bought our first house and therefore I wanted to check how the interest would change our taxes. [...] Anything that I could do to lower my taxes?"
Eh? That's not how it should work for mortgage interest. Mortgage interest isn't an AMT preference item (apart from on home equity loans in some circumstances). Increasing any interest on a mortgage used to acquire the home should not increase AMT. It sounds as if something is being entered incorrectly. I use TurboTax so I'm not sure how TaxAct processes this.
Also it is never true that increasing Schedule A deductions will increase AMT Income. If the Schedule A deductions are AMT preference items, then increasing the Schedule A deductions will not decrease AMT Income, but it won't increase it either. Form 6251 will just add the extra amounts deducted back in, and AMT Income (line 29 on the 2008 Form 6251) will be the same.
Although I already said essentially the same thing two replies earlier, let's note that many folks will gladly pay more interest (tax-deductible or not) if it improves their cash flow, so it must make sense to them.
Many of us in the real world have figured out that "how can I lower my taxes" should be translated into simply "how can I have more left over."
Example: suppose you have a $320K, 30-yr fixed 5.125% mortgage. Now you're about ten years into it, with a monthly payment of $1,742 and annual tax-deductible interest of about $13,340.
You re-finance your current balance of $263,750 into a higher rate 5.5%
30-yr mortgage. Although you have increased your annual interest expense by over $1,000, you have reduced your annual taxes (federal and state combined) by probably $300, and you have reduced you annual payment to the bank by almost $3,000!
For many, taking the extra $3,300 cash per year is a no-brainer, and results in a nice living for more than a few mortgage brokers as well. Taking inflation and liquidity concerns into account usually just increases the appeal of the maneuver.
Although I was puzzled by the OP's desire to play "what-if" with mortgage interest, I replied (separately) to the two questions he asked, as factually as I could without imposing my own economic values. If/when he ever writes back, we'll know better what his next (or "real") question is.
Right... as Art Kamlet and others have mentioned in the past, before you start playing "what-if" with tax software, it's best to have
*everything* affecting your return completely entered, and then change just *one* thing at a time. Since this is the OP's first house and presumably first mortgage, he's probably never received a 1098 (Mortgage) statement before, and may not even be distinguishing correctly between principal, interest, PMI, and escrow amounts.
And one more thing, for the OP if he is still reading: don't forget to check your eligibility for the $8,000 first-time home buyer's credit.
Thanks all for your comments. I tried turbotax yesterday and the full amount of interest was tax deductible. i went back to taxact but didn't see where I might have made a mistake, so that is still puzzling. At least I have confirmation that TurboTax seems to work as I had thought before we bought the house.
But what about paying an extra $100 of interest to lower taxes by $25, and reduce the principal payments by $150 (by extending the term)? If your income drops, that can make sense.
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