HOME MORTGAGE INTEREST: HOW MUCH IS DEDUCTIBLE?
Many who have purchased homes and owned them for ten or twenty years are often surprised by the amount of equity that has increased over time. I know a client who purchased a three family home in Jamaica Plain, MA, in 1976 for $15,500. In 2004, when they went to sell the home, it was worth $630,000. This holds true for today’s market. There is an upside and a downside to this fact. Throughout the years of ownership, many homeowners re-financed and took cash out to fix up the home, but some only used those funds to purchase items not associated with the home, like cars; boats; vacations. After October 13th, 1987 the interest on that re-finance may not have been fully deductible.
Prior to Oct 13th, 1987 a homeowner could refinance as many times as they wanted and do anything they wanted with the proceeds, and the interest was fully deductible as mortgage interest on the itemized deductions on their tax returns. However, on October 13th, 1987 the rules changed and the homeowner was burdened with new terms, `Acquisition Indebtedness and Home Equity Loans.’
Before we discuss these terms, let’s define a `qualified home.’
In order to qualify for a home mortgage interest deduction, your debt must be secured by a qualified home, like your primary or secondary reisdence. The property itself can be a house, condominium, cooperative, mobile home, house trailer, boat, or similar property that has sleeping, cooking, and toilet facilities.
The interest you pay on a mortgage for a third residence may be deductible if the proceeds of the loan were used for business, investment, or other deductible purposes. Otherwise it will be considered personal interest and it is not deductible.
Main home. You can have only one primary residence at any one time. This is the home where you ordinarily live most of the time.
Second home. Your second property may be a qualified home if you do not use it for rent or resale to others during the year. You do not have to use the property during the year for it to be a qualified home.
This article will only discuss the features of a primary and secondary home with regard to personal residence, which will apply to both a primary and secondary residence.
Home Acquisition Debt
“Home acquisition debt” is an example of mortgage taken out after October 13, 1987, to buy, build, or substantially improve a qualified home (your primary or secondary home). It must also be secured by the home.
If your mortgage amount is higher than the cost of the home plus substantial improvements, only the debt equivalent to the mortgage qualifies as the “home acquisition debt.” The additional debt may qualify as home equity debt (discussed later).
Home acquisition debt limit. At any time, the total amount that you can treat as a home acquisition debt for your primary or secondary home can’t be more than $1 million ($500,000 if married, filing separately). Debt over this limit may qualify as home equity debt (also discussed later).
Refinanced home acquisition debt. Any secured debt you use to refinance home acquisition debt is treated as home acquisition debt. The new debt, however, will qualify as home acquisition debt only up to the amount of the balance of the old mortgage principal just before the refinancing. Any additional debt not used to buy, build, or substantially improve a qualified home is not home acquisition debt, but may qualify as home equity debt (discussed later).
Mortgage that qualifies later. A mortgage that does not qualify as home acquisition debt because it does not meet all the requirements may qualify at a later time. For example, a debt that you use to buy your home might not qualify as home acquisition debt because it’s not secured by the home. If the debt is later secured by the home, however, it might qualify as home acquisition debt after that time. Similarly, a debt that you use to buy property might not qualify because the property is not a qualified home. If the property later becomes a qualified home, however, the debt might qualify after that time.
Mortgage treated as used to buy, build, or improve home. A mortgage secured by a qualified home may be treated as home acquisition debt, even if you do not actually use the proceeds to buy, build, or substantially improve the home, if funds expended for that purpose meets time requirements. If this is the case, you will want to consult a professional.
Home Equity Debt
If you took out a loan for reasons other than to buy, build, or substantially improve your home, it may qualify as home equity debt. Debt that you incurred to buy, build, or substantially improve your home to the extent that it is more than the home acquisition debt limit (discussed earlier), may qualify as home equity debt.
Home equity debt is a mortgage you took out after October 13, 1987, that:
- Does not qualify as home acquisition debt or as grandfathered debt, and (debt prior to Oct 13th 1987)
- Is secured by your qualified home.
Home equity debt limit. There is a limit on the amount of debt that can be treated as home equity debt. The total home equity debt on your primary or secondary home is limited to the smaller of:
- $100,000 ($50,000 if married filing separately)
There are other considerations on home equity debt limits which may apply to a unique set of facts and if you have owned your home prior to Oct 13th 1987 and/or you have grandfathered debt; you may want to re-visit this term with a tax professional.
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