Wednesday, January 18, 2012

Deducting Excess Residence Interest

Taxpayers may deduct interest on up to $1mil of qualified residence initial acquisition interest and up to $100,000 of home equity interest. Many taxpayers do not realize that once you pay down an original mortgage, if you receive proceeds increasing the mortgage upon a refinance, that debt actually falls under the home equity limit for purposes of these calculations. Primary mortgage does not necessarily equal initial acquisition debt.

Interest on debt which exceeds these thresholds, and which was used for other than improving the property is secured by, may be eligible for deduction on a rental or business schedule of the proceeds of the loan can be traced to that endeavor. It may also be nondeductible such as if used to pay off credit card debt, loan to children, go on vacation, purchase non-business assets, etc. There has been a lack of clarity regarding allowable methods for prorating the interest when necessary.

“Chief Counsel has determined that taxpayers can use any reasonable method to allocate debt that exceeds the limits, including the exact method, the simplified method, the Pub 936 method, and a reasonable approximation of those methods. Regardless of the method used, the taxpayer may allocate amounts that exceed the limits, according to the use of the debt proceeds. Taxpayers can elect to treat the debt as not secured by a residence, but do not have to make the election. If an election is made, the entire debt is treated as not secured by the residence; if an election is not made, only the debt portion that exceeds the limits is traced according to the use of the proceeds.” (CCA 201201017)

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