There are rumblings coming out of the east coast of a new IRS target – your mortgage interest deduction. Yes, I’m talking about the interest deduction you take on Schedule A as an itemized deduction.
So far, all I’ve heard about is the IRS notices on that item. Initially, they’re asking for proof of the loan amount. My guess is that they’re probably coming after the three limitations on the amount of mortgage deduction you can take. For years now, some lenders have advertised about “debt consolidation loans” so you could get a deduction for your car, boat, credit cards, whatever. And the fact is, you simply can’t do that.
Here are the three limitations:
(1) You can only deduct the interest on the first $1 mill in mortgage loans on your first and second homes combined. Interest on the debt over that amount is not deductible.
(2) You can only deduct interest related to acquisition indebtedness. This is defined as: “Home acquisition debt is a mortgage you took out after Oct. 13, 1987, to buy, build or substantially improve a qualified home (your main or second home).”
(3) You can only deduct $100,000 on a home equity loan. This is on top of the $1 mill limitation for the initial loan.
Okay, let’s walk through an example:
In 1999, you bought a home for $300,000, put 20% down and got a loan for $240,000. Years go by and you pay the loan down to $230,000. You refinanced and got a loan for $400,000. You can only take a mortgage interest deduction based on the the acquisition indebtedness – now $230,000.
That means there is $170,000 that is not deductible under (1) or (2). But remember you get another $100,000 for a home equity loan. So you actually get to deduct interest for $330,000 of the $400,000 loan.
What happens to the rest? You don’t get to take it as a mortgage interest deduction unless you can prove that the money was used to substantially improve the property.
It’s my guess that is what the IRS is after here. They want to see what you did with the money from any cash-out refi’s. And if it went into buying real estate that is now upside down, too bad – no deduction.
For more information on the Tax Implications of Real Estate Losses, don’t miss this week’s special “Tax Implications of Real Estate Losses” along with the “IRS Survival Guide for Real Estate Professionals with Real Estate Losses” available at www.TaxLoopholes.com.