That rule *is* in Pub 936. IRS pubs are not final authority, nor should they be dismissed out-of-hand. Also, the full $300K, if secured by a qualified home, is defined as home equity debt, whether the interest on it is deductible or not.
From the pub:
"Mixed-use mortgages. [...] Principal payments on a mixed-use mortgage are applied in full to each category of debt, until its balance is zero, in the following order:
First, any home equity debt, 2. Next, any grandfathered debt, and 3. Finally, any home acquisition debt."
Home Mortgage Interest Adjustment Worksheet?Line 4
Enter the total of the home mortgage interest you deducted on lines 10 through 12 of Schedule A (Form 1040) and any qualified mortgage insurance premiums you deducted on line 13 of Schedule A (Form 1040) 1.
Enter the part, if any, of the interest included on line 1 above that was paid on an eligible mortgage (defined on this page). Include any qualified mortgage insurance premiums included on line 1 above that were paid in connection with an eligible mortgage 2.
Line 1 will be the interest on $1.1 million. Is that right? Line 2 will be the same as line 1.
Eventually, line 6, the part of mortgage interest not allowed under AMT, will be zero.
Eligible mortgage. An eligible mortgage is a mortgage whose proceeds were used to buy, build, or substantially improve your main home or a second home that is a qualified dwelling. A mortgage whose proceeds were used to refinance another mortgage is not an eligible mortgage.
Of course, the above is a simplistic interpretation of the instructions, which may or may not be correct.
That could be the IRS's position, and they usually win in tax court.
This is incorrect. The percentage is going to change over time. It will continue to rise until such time that the qualified loan limit (assuming no grandfathered debt for this example) of either $1.0M or 1.1M with HE debt and the average balance on all the debt on qualified homes for the year is also the same number. At that point all interest is deductible because the loan limit divided by the average balance of all qualified debt = 1.0. The best example of this is to use Table 1 on page 11 of Pub 936. This worksheet is a correct interpretation of the law. Enter a set of numbers for this year that are in excess of $1.1M and compute the percentage deductible. Then assume some payoff of principal with a new balance that is still over the limit for the next tax year. You will see that the percentage deductible goes up.
Bear in mind that you have to use average loan balances. The IRS offers a variety of different methods for computing the average loan balance for any given year.
WRONG! The amount borrowed remains constant over the life of the loan. It is NOT adjusted by the amount repaid. The percentage of allowable interest is computed ONCE and applied to all years until paid off or refinancing (for more than the remaining balance) occurs.
So if someone gets a $2 million mortgage, and 2 months later repays $1 million, you say the interest subsequent to that is only 50% deductible? Yet if he refinances, it suddenly becomes 100% deductible? That makes less sense than tax law usually does.
So I went to the source.
formatting link
In the definition of "acquisition indebtedness"
TITLE 26 > Subtitle A > CHAPTER 1 > Subchapter B > PART VI > Section 163
(h) (3) (B) (ii) $1,000,000 limitation 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).
That indicates to me that in year 2, when the total balance is under $1,000,000, it's all acquisition indebtedness. I saw nothing referring to the original amount of the debt, other than in relation to the grandfather clause (for mortgage debt prior to October 13,
That doesn't seem consistent with the law or regulations. I think the Pub 936 instructions seem closer to the law than the "constant percentage" interpretation.
">>WRONG! The amount borrowed remains constant over the life of the loan. It is NOT adjusted by the amount repaid. The percentage of allowable interest is computed ONCE and applied to all years until paid off or refinancing (for more than the remaining balance) occurs."
I am totally flabbergasted that what is so clear to me is not clear to you. The worksheets in Pub 936 are consistent with the regulations in 1.163. They both clearly state that for any tax year, you enter the average balance of all of your home acquisition debt for that year! That's why Table 1 has you enter the balance on Line 2 and compares it to the $1,000,000 limit on Line 3 (let's assume for this exercise there is no grandfathered or home equity debt). If you have no grandfathered debt and home equity debt, your qualified loan limit will be $1M (Line 8 of the Table). In computing how much of your interest is deductible, you enter the average balance of all mortgages on all qualified homes for the current year! This is very explicitly stated in the Line
9 instructions for the table. It is also consistent with the Regs that tell you how to compute your annual average balance. If you have a mortgage that is not interest only, and you don't refinance, then this average balance is going to go down each year as you pay off principal. As this number is the denominator of the formula, and the $1M limit is the numerator, the percentage allowed to deduct will go up each year. The Regs tell you how you go about computing the average balance for each year.
Using your interpretation, there would be no need for an annual worksheet. There would be no need to compute average balance.
As I have stated elsewhere, Alan's interpretation is more consistent with the language of the statute, and I was able to find no regulation to the contrary.
Plus, it's what is in the Pub. You can rely on written advice from the IRS to avoid penalties. It's funny how often people will say the IRS pubs are not "final authority", but they never come out and say the pubs are wrong, either.
I have seen tax textbooks that had the same > If your only access to tax law is IRS publications then you have too
If your access to tax code and regulations is so broad that you can't always make sense of it, cross-reference it, or be sure you have the very latest, then you could do much worse than to limit yourself to the IRS pubs.
Oh, I have been known to do that. On occasion I might even claim that a regulation is wrong. But that doesn't happen very often.
It seems to be a natural mistake. The rule concerning refinancing does seem to lock in the value, so that future refinancing at a higher level would not permit increasing the deduction. So thinking the same kind of rule would apply to initial values over $1 million is not unreasonable.
But that's not what the statute says. It says that qualified interest is "any interest" that is paid during the year, but only limited to interest on a principal amount (for "any period") of $1 million or less. It doesn't say it applies to interest only on the initial proportion of principal that qualified for the deduction.
The initial definition of "highly paid" (for use with pension plans) was, IIRC, "paid more than 2/3 of the employees". That was in the code.
I noted that a doctor's office with two doctors both earning $200,000 per year and 3 other less-paid employees had _no_ highly paid employees by that definition. The IRS regulations, when published, did not follow the wording of the law.
What you're missing is that the principal of the loan is determined ONCE. Look at the language in the following subsections with regard to pre-October 13, 1987 debt [Section 163(h)(3)(D)] and it's clear that the debt is incurred ONCE, on the date the (or each) loan is taken out.
The reason for having a worksheet every year is that there may be new debt in any year. That does not mean that one must recompute every year. Note also that the regulations, at TR 1.163-10(e)(4)(iii), address "average balance" ONLY when the debt is allocable to MORE THAN ONE EXPENDITURE CLASS and the total debt exceeds the statutory limits for some class. This is because amounts allocated to personal expenditures, otherwise not permiited, are deductible as residence interest if secured and not over limit. TR 1.163-8 includes ordering rules for determining what class of debt is paid off first.
The worksheet does NOT apply if there's no diversion of principal to a non-residence-interest-qualified expenditure. If the debt is all acquisition and/or equity debt (without regard to the respective limits) - i.e. its proceeds were applied to a single purpose, one cannot use the worksheet per the TRs.
To continuously recompute each year is not consistent with the statutory language, except for home-equity lines of credit - TR 1.163-8(d)(3), or TR
1.163-10(e)(2)(i), when (A) debt exceeds FMV (i.e. insolvent asset), or when (B) debt exceeds basis (e.g. casualty loss adjusted), or a change in usage (i.e. allocation between Schedule A and Form 8829 for business use of home, etc.).
TR 1.163-10(f)(2)(iii) also makes it clear, in that the FMV limitation is [also] computed once - "as of the time the debt is first secured."
This is the way I learnt it when working for the IRS. Nothing in the Chief Counsel Memo suggests that such was wrong, except for their specific change in policy of classifying acquisition debt over the limit as home-equity debt (up to its limit), thus ignoring the parenthetical clause of 26 USC
So the general concensus seems to be that I CAN deduct interest on up to $1.1M. No so clear on where you all stand as to whether I will be able to deduct the interest going forward on the full $1.1M or whether over the years I need to reduce that amount by a portion of my principal payments (even when my outstanding morgage amount continues to exceed $1.1M as Mr. Utterback proposed.
See my post and Mark Bole's follow up dated Feb 25 and Feb 26 respectively. Principal payments apply to the "personal" loan balance first until that portion is zero.
"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)."
Note that it says "for any period shall not exceed $1,000,000." It doesn't say "on the date of acquisition..."
Likewise the language concerning home equity indebtedness says,
"The aggregate amount treated as home equity indebtedness for any period shall not exceed $100,000 ($50,000 in the case of a separate return by a married individual)."
Again, "for any period," not "on the date of acquisition."
§163(h)(3)(D), as you note, deals with debts incurred before
10/13/87. I don't see how that has anything to do with debts incurred after that. If there were something in that provision that said that pre-87 loans would NOT be revalued every year if they were over $1,000,000, that would imply that they otherwise should be. But there is no such provision.
1.163-8(d)(3) does not refer at all to home mortgage interest. Even if it did, it can't supercede the statutory language I noted above. And 1.163-10(e)(2)(i) doesn't talk at all about the $1 million limitation. How can it make a rule about calculating the limitation without talking about it at all?
That regulation also talks about evaluating the price on the date of acquisition. But it is for a different purpose. As noted above, the statute (which trumps any regulation) says that the limitation applies to "any period." To me that means that if, in any year, the principal amount owed is reduced, it is recalculated for that "period."
The IRS often gets things wrong. That's why there is so much litigation against them, and why the IRS loses its share of those cases.
I think you have misunderstood the debate. The issue isn't whether you can deduct interest on the full $1.1 million.
The question is, if the total loan is more than that amount, as time goes on and the principal of the loan goes down to $1.1 million, whether you can deduct the full amount of interest at that time, or whether you are limited to the proportion you could take when the house was first purchased.
You can trace the debt to see what the money was used for. BUT you do not get to assign your payments to ONLY the portion of the debt that suits you. You're reducing the entire debt, not just some portion of it.
BeanSmart website is not affiliated with any of the manufacturers or service providers discussed here.
All logos and trade names are the property of their respective owners.