Mortgage Interest Limitation

In ILM 200940030, the IRS says you can now treat up to $100K of the excess above $1M as home equity debt. The maximum is still $1.1M but you don't have to actually have a home equity loan. The fair market value limitation still exists.

I forgot to add the link:

In addition, this position was 180 degrees different than prior tax court decisions. Here's an excerpt from the memorandum:

We recognize that the position taken in this memorandum is inconsistent with Pau v. Commissioner, T.C. Memo. 1997-43 and Catalano v. Commissioner, T.C. Memo. 2000-82, regarding the definition of acquisition indebtedness in § 163(h)(3)(B). However, we believe that the position in this memorandum is the better interpretation of §163(h)(3)(B) and (C).

Yes, I've both read and encountered the situation. BUT I do not think is your real question. Tell us what your real question is and we'll try to answer it.

Gene E. Utterback, EA, RFC, ABA

Thanks for your answers. My real question is whether in my tax return I should attempt to deduct interest on $1.1M of acquistion debt or cap the interest at interest on the first $1M since I don't have any home equity debt.

only deductible on at most $1M

Is it possible to deduct mortgage interest on the 2nd home as investment interest (subject to investment income of course)? If yes, what requirements does the second home have to satisfy in order to be treated as investment interest?

Under the legal memorandum issued by the IRS, you may elect to treat $100,000 of your acquisition debt as home equity debt. As such, if you so desire, you can deduct interest you paid on $1.1M of acquisition debt.

Maria - in YOUR case, you can elect to treat $100K as acquisition related equity debt and you CAN deduct the interest on $1.1M in loans.

You should also be aware that this amount will decrease annually. You'll need to maintain some sort of ledger to track the debt and you'll need to adjust down your deduction annually - many non pros get lost with this so I'll try to give you an example.

Say your mortgage was really for $1.3M; You can deduct the interest on $1.1M - this represents 84.615% of your total debt. So you can deduct ONLY 84.615% of your mortgage interest.

A few years will pass and you'll pay down the mortgage to the point where the remaining balance is say $800K (that's all that's left from the original $1.3M) you still get to deduct ONLY 84.615% of the interest on this loan. Just because the loan balance is NOW below the $1.1M threshold doesn't mean you can deduct all of the interest.

AND if you refi or take out an equity mortgage at this POINT you'd only be able to deduct the interest on the FIRST $100K of new money.

AND unless you used that $100K to improve the home, you'd have a tax adjustment item for AMT purposes.

Hope this helps, Gene E. Utterback, EA, RFC, ABA

| Say your mortgage was really for $1.3M; | You can deduct the interest on $1.1M - this represents 84.615% of your total | debt. | So you can deduct ONLY 84.615% of your mortgage interest. | | A few years will pass and you'll pay down the mortgage to the point where | the remaining balance is say $800K (that's all that's left from the original | $1.3M) you still get to deduct ONLY 84.615% of the interest on this loan. | Just because the loan balance is NOW below the $1.1M threshold doesn't mean | you can deduct all of the interest.

Interesting. I've sometimes considered the notion of using a temporarily larger mortgage to compensate for a temporary cash flow shortage. It sounds like you could shoot yourself in the foot doing this. Consider an example to see if I am understanding correctly. Ignore the extra $100k possibility.

You get a $2M mortgage for a home purchase knowing that soon you will have $1M to pay it down. Say you have some bonds coming due or are getting a bonus or maybe you are even about to close on the sale of another house but you can't quite do it in time. A few months later you do indeed get your $1M and pay down the $2M mortgage to $1M. Does this mean that for the rest of the life of the mortgage you are restricted to deducting only 50% of the mortgage interest?

Dan Lanciani ddl@danlan.*com

No.

I don't see where that interpretation is coming from. The amount of debt is always referred to as the original amount borrowed, not the balance remaining. The refinance characterization rule at Section 163(h)(3)(B) tells us this.

Even if it weren't, I'd say that the OPPOSITE effect results: As a taxpayer pays in, he accumulates equity, so before the additional $100k of equity debt related interest deduction may apply, there first must be $100k of equity. (There are some people in the "junk loan" market who got a second mortgage to satisfy the down-payment requirements at purchase of the first mortgage -- but granted those generally weren't for $1M+ homes.)

I also note that the IRS document appears to be a change in position, even without regard to the Tax Court decisions cited, as those cases were [previously] consistent with the prior position as the IRS internally taught its personnel after the TRA'86 changes.

Does anyone know if this interpretation applies to years before its release date? If so, time to get the amended returns for 2006 cranking before the deadline....

Alan answered your question in his first response.

Yes, under the original interpretation. Under the interpretation from the CCMemo, you get 55% (50% as $1M acq. and 5% as the $100k equity debt).

And only $1million would be allowable under AMT, although I think someone mentioned that already.

Of the entire $1,300,000 balance described in the OP, $1,000,000 is acquisition indebtedness, $100,000 is equity indebtedness and $200,000 is personal indebtedness. Principal payments by the debtor first reduce the personal indebtedness. When that reaches zero, equity indebtedness is reduced. When the equity indebtedness balance reaches zero, payments reduce acquisition indebtedness.

Which part of publication 936 mentions this rule?

The instructions to form 6251 allow the 100k if it is used to acquire, build, improve your home.

The portionof excess acquisition debt is now treated as HE debt.

Are you saying that when there is debt exceeding 1 million, the first

100,000 above that million is not treated as home equity debt for AMT if it was used to buy build or improve? And that the AMT instructions say that?

There are two rules, and when they conflict, which trumps which?

Rule 1: HE Debt is treated as Acq Debt if used to buy build or improve. And that allows HE Debt to be relabeled and treated as Acq debt even fo AMT. Rule 2. When Acq Debt exceeds 1million, the first 100,000 above this amount is treated as Home Equity Debt even if used to BB or i.

I believe when these two rules seem to conflict, rule 2 trumps rule 1.

Publication 936 is not the final authority on anything. That a rule relevant to this issue fails to appear in Publication 936 means that the publication is incomplete, not that the rule is wrong. Gene Utterback is correct.

If your only access to tax law is IRS publications then you have too little access to be offering tax advice or other tax services, in my opinion.

Actually I'm not so sure. That position seems to be a reasonable extrapolation from the rule that a refinance can't increase the amount (or proportion) of debt qualifying for the interest deduction.

But the statute doesn't say the same thing with respect to the amount the original loan exceeds $1,000,000. It says, first, "The term 'qualified residence interest' means any interest which is paid or accrued during the taxable year..." on a proper debt. Note the word "any."

It goes on to say, "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)."

It doesn't say the deduction is limited to the portion of the debt originally allowed the deduction. I was unable to find any regulation on this point.

Personally it looks like the statute allows the full deduction if a loan that started out at over $1,000,000 goes down, the deduction on the full $1,000,000 is allowed to the extent the loan remains that high.

I'll certainly agree with that.