Magazine article The CPA Journal

Mortgage Interest

Magazine article The CPA Journal

Mortgage Interest

Article excerpt

With the passage of TRA 86, tax practitioners and their clients have faced substantial tax law changes. In particular, the phase-out of the personal interest deduction has moved the mortgage interest deduction into the limelight as an important tax planning strategy.

Mortgage interest is interest incurred on a loan secured by a qualified residence. Loans secured by a principal residence, including first and second mortgages, home equity loans, and refinanced mortgages are includable in the definition of mortgage interest. The IRS has set limitations on the deductibility of mortgage interest; these limitations depend on the date the mortgage was issued, the amount of the mortgage, and the use of the proceeds.

A qualified residence is defined as a house, cooperative apartment, condominium, house trailer, or a boat, provided it includes the basic living accommodations, including sleeping space, toilet and cooking facilities. A qualified residence includes a taxpayer's principal residence or second home. The taxpayer's second residence may be unoccupied, partially occupied, or rented to another party. If the second residence is rented, it will be subject to the personal use requirements relating to vacation homes. It will qualify as a personal residence if used by the taxpayer more than the greater of 14 days, or 10% of the number of days during the year that it was rented at fair value. If the taxpayer did not rent the residence at any time during the year, it will be considered a qualified residence. Regulations state that the term "rental" is defined as holding a residence for rental or resale.

Mortgage interest is subject to certain limitations to be fully deductible. Acquisition indebtedness incurred prior to October 14, 1987, is not subject to the limitations imposed on indebtedness incurred subsequently. A $1 million limitation is imposed on the principal amount of acquisition indebtedness incurred after October 14, 1987.

Acquisition Indebtedness

Sec. 514(c) defines the term acquisition indebtedness as the unpaid amount of:

1. Indebtedness incurred by the organization in acquiring, substantially improving or constructing such property;

2. Indebtedness incurred before the acquisition or improvement of such property if such indebtedness would not have been incurred but for such acquisition or improvement; and

3. Indebtedness incurred after the acquisition or improvement of such property, if such indebtedness would not have been incurred but for such acquisition or improvement and incurring such indebtedness was reasonably foreseeable at the time of acquisition or improvement.

Debt can qualify as being incurred to acquire, construct, or substantially improve a residence under the tracing rules of Reg. 1.163-8T. The determination of whether debt is incurred in acquiring, constructing, or substantially improving a residence will be made independently of the determination of whether the debt is secured by the residence and without regard to whether the residence is a qualified residence at the time the expenditures are made or the debt is incurred. Therefore, a debt that is not initially secured in acquiring a qualified residence may become acquisition indebtedness at the time the debt is subsequently secured by the qualified residence. Additionally, debt incurred in acquiring property that is not a qualified residence at the time the debt is incurred may become acquisition debt at the time the property subsequently becomes a qualified residence if the debt is secured by the qualified residence. …

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