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acquisition and Home equity loan interest deduction

Level 3

Facts: .in 2016, the taxpayer took a acquisition loan  and loan was secured by his principle residence. The outstanding loan amount is $550,000 in 2019.

in 2017, the taxpayer took a acquisition loan  and loan was secured by second home. The outstanding loan amount in 2019 is $150,000. In Nov 2019, he converted the second home to a rental property.

in Nov 2019, the taxpayer purchased the a new home as a second home. the loan amount is $300,000.

In 2018, the taxpayer took a home equity loan which was secured by his principal residence. However the proceeds were used to improve a rental property. The outstanding balance in 2019 $150,000.

Question:

1) which limitation should be used when calculating deductible 2019 mortgage interest $750,000 or $1m on Schedule A? 

2) Is 100% of interest or only a portion deductible on the Schedule E ? or it is not deductible at all, because total loan amount is over $1m?

 

thanks

 

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Level 13

Thanks Rick, I missed the fact that the switch in houses occurred in 2019, and that the OP is doing that 2019 tax return.  As you pointed out, the OP needs to sort out the timing for where to apply the interest.

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Level 13


$550,000 on main home - Deductible on Schedule A, but see third point for limitations.

$150,0000 on home that is now a rental - Fully deductible on Schedule E.

$300,000 on second home - Deducible on Schedule A, but because this was after change, you are limited to $750,000 between this one and the Main Home (fully use the higher interest one, and use the lower interest one for the rest).

$150,000 used to improve rental - Fully deductible on Schedule E.

 

Level 3

I am sorry. I forgot to mention that I am doing the 2019 tax return not 2020 tax return. so the treatment would be the same on his 2019 tax return?

Thank you very much  for your reply.

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Level 13

Yes, the same rules apply.

Level 11

You're asking about interest but you're talking about principal.

Since 2019 is the conversion year the interest will need to be allocated appropriately BEFORE it can be limited.  There are several methods available to do this, however some of them require that the property be used for all 12 months.  Personally I use the daily average balance (which will reflect the actual interest paid for each bucket).  Often one of the other average methods will give you a better result but you can get into the weeds pretty quickly in the transition years.  I bill by the hour so it doesn't make sense for me to spend an extra 30 minutes of billable time down the rabbit hole in order to save a client $15 in tax.

There is a provision which allows you to "switch" your second home mid-year if you meet certain conditions.  One of the conditions is that you purchase a new second home during the year.  See Pub 936 under Qualified Home.

Main home is still main home with 100% acquisition debt interest.  The $150K "second home that's now a rental property" is good up until the earlier of 1) the purchase of the $300K "third home that qualifies as a second home after the purchase date" home or 2) the conversion of the "second home that's now a rental property" to a rental property.  Then you're over the acquisition debt limit and you're stuck calculating by how much for how long (which I assume changes every time there's a payment since most loan payments involve both principal and interest).

The interest on the rental property period for the "second home that's now a rental property" is calculated from the date the rental was available to be rented.  So interest after that date ends up on Sch E.

The interest on the home equity loan (assuming proper tracing of the loan proceeds) would be deductible on the Sch E for the property that was improved by the proceeds.  The fact that it was a home equity loan is not relevant for 2018 or 2019 (or likely through 2025 but that may depend on how much of TCJA get unraveled by Congress in the coming months).  If the equity debt limit is changed from $0 to something else (such as the old $100K) then the regs kick in and a portion of this becomes home equity debt with part of the interest deductible on Schedule A (unless you make a Sec. 1.163-10T(e) election to treat it as not secured by the home which kicks it all back to Schedule E).

Be sure you charge enough for this mess.

Rick

Level 13

Thanks Rick, I missed the fact that the switch in houses occurred in 2019, and that the OP is doing that 2019 tax return.  As you pointed out, the OP needs to sort out the timing for where to apply the interest.

View solution in original post

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