Virtually all personal interest expense is not deductible. Fortunately, there is an exception for mortgage interest expense. Mortgage interest expense is deductible as an itemized deduction.
Categories of Mortgage Interest Deductions
There are two categories of mortgage interest:
• Home Acquisition Debt which is (1) incurred to acquire, construct, or substantially improve a residence and is (2) secured by such residence
• Home Equity Debt which is secured by a residence and, unlike home acquisition debt, can be used for any purpose without affecting its deductibility
Mortgage debt must be on a qualified residence which includes the taxpayer’s principal residence and up to one additional personal residence owned by the taxpayer. If the taxpayer owns two or more additional residences, the taxpayer can choose which house is treated as the second residence. The taxpayer can alternate which house is considered the second house each year (the one with the higher interest expense should be the second residence).
Limits on Deductibility
Home acquisition debt is limited to $1 million dollars and home equity debt is limited to $100,000. A recent 9th Circuit case answered the question: Are the $1 million and the $100,000 limits applied on a per taxpayer basis or on a per residence basis for unmarried joint owners of property? For married couples, the above limits are halved so a married couple’s total acquisition debt limit is $1 million and the total home equity debt limit is $100,000.
Example: John and Suzy are brother and sister. They purchase a $2.5 million dollar home with a $2.2 million mortgage. If the mortgage debt limits are on a per residence basis, the total amount of qualifying mortgage debt is $1.1 million*. Since the total mortgage is $2.2 million, only half of John and Suzy’s mortgage interest will be deductible.
• In prior case law, it was held that the $100,000 home equity debt limit could be applied to an acquisition of a home. This, in a way, increases the home acquisition indebtedness limit to $1.1 million.
If the mortgage debt limits are on a per taxpayer basis, John and Suzy each have $1 million of acquisition debt and $100,000 of home equity debt on which interest will be deductible. Since the sum of their limits is $2.2 million, all of their interest expense is deductible.
If John and Suzy were married, their total home acquisition debt limit is $1 million and their total home equity debt limit is $100,000. Since the total mortgage is $2.2 million, only half of their mortgage interest is deductible.
This recent court case affects unmarried joint owners of mortgaged property. The per residence limit continues to apply to married people.
Taxpayers now have substantial authority for taking the position that the qualified residence interest debt limits can be applied on a per taxpayer basis in situations where qualified residences are co-owned by unmarried individuals.
To see how this applies to you, give us a call at 248-538-5331.
Buzzkill Disclaimer: This post contains general tax information that may or may not apply in your specific tax situation. Please consult a tax professional before relying on any information contained in this post.