Contributed by:
Tracie Southerland
Opes Advisors
T: (650) 319-1603
Cell: (650) 255-1477
Email: tsoutherland@opesadvisors.com
In February I wrote about the coming crackdown by the IRS regarding mortgage interest deduction. Since the IRS is scutinizing tax returns for abuse of mortgage interest deduction, I thought it might be good to revisit the basics of IRS Publication 936 which addresses this issue specifically. For your light reading, I direct you to the IRS Publication that explains this in incredible (and excruciating) detail.
According to the IRS, mortgage interest is deductible on up to $1,100,000 borrowed. This limit is divided between home acquisition debt and home equity debt as explained below. There are important restrictions to this as described below.
The mortgage debt must be a secured debt. A secured debt is one in which you sign an instrument (such as a mortgage, deed of trust, or land contract) that:
• Makes your ownership in a qualified home security for payment of the debt;
• Provides, in case of default, that your home could satisfy the debt, and
• Is recorded or is otherwise perfected under any state or local law that applies.
Your debt must be secured by a qualified home. This means your main home or your second home. A home includes a house, condominium, cooperative, mobile home, house trailer, boat, or similar property that has sleeping, cooking, and toilet facilities.
You can have only one main home at any one time. This is the home where you ordinarily live most of the time. A second home is a home that you choose to treat as your second home. If you rent it out part time, there are rules regarding how long during the year you must use it to have it treated as a second home and not as an investment property. Consult the IRS Publication for clarification.
Home Acquisition Debt. This is a mortgage taken out to buy, build or substantially improve a qualified home. The total amount you can treat as home acquisition debt at any time on your main home and second home cannot be more than $1 million. If a buyer does not take a mortgage at time of purchase, they have 90 days to place a mortgage on that qualified home to still treat it as home acquisition debt.
Here is an example of a typical borrower:
Let’s say a buyer obtains a $1,000,000 loan at time of purchasing a primary residence. They then inherit lots of money and pay the balance down by 50%. This reduces the “acquisition” debt to $500,000, and the mortgage interest costs. Later, they need money again, and they re-borrow the $500,000. They are back to 1M in mortgage debt. Is it all deductible interest cost? It depends.
When acquisition debt is reduced, and then “re-borrowed”, the borrower is restricted to mortgage interest deductions on $100,000 of home equity debt. The additional interest cost on $400,000 of mortgage debt is not deductible, unless the funds are used for improvements to the property (i.e., major remodel), or for other purposes that a CPA can specify and advise on.
“The 90 Day Rule”: Buyers sometimes purchase their homes for cash with the aim of winning in a multiple offer situation, simplifying the purchase process, or closing quickly. Some plan to obtain financing after closing. The timing of this financing matters.
The 90 Day Rule specifies that “you buy your home within 90 days before or after the date you take out the mortgage”. This means that the IRS requires mortgage financing be placed within 90 days of closing to be considered “acquisition” debt for deductible mortgage interest. If this timing window is missed, you may only be able to deduct interest on $100,000 of debt (home equity debt).
