Discussion:Mortgage vs. Home Equity

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Discussion Forum Index --> Basic Tax Questions --> Mortgage vs. Home Equity


Discussion Forum Index --> Tax Questions --> Mortgage vs. Home Equity

Maughact (talk|edits) said:

4 February 2011

I have a strange situation. I have a client who took out a mortgage on his main home in the amount of $200,000. He paid his old mortgage off years ago. The reason he took out the mortgage is because the interest rates are so low, he wanted to get cash in case he buys another home in another state in the next couple of years. The way I see it, it's a home equity loan limited to $100,000 and therefore only 1/2 the interest is deductible.

Would that be correct?

Death&Taxes (talk|edits) said:

4 February 2011
Yes, it is limited to interest on $100,000 based on the facts you present.

Captcook (talk|edits) said:

4 February 2011
Did he invest the $$? If so, you can make an election to treat that portion as investment interest and at least get some benefit out of it. I can't think of the Reg at the moment 1-163.XX

Maughact (talk|edits) said:

4 February 2011
I didn't even think of that. I believe he just has it in a savings account. That would be considered an investment right?

Captcook (talk|edits) said:

4 February 2011
Making that judgment is why you get the big $$.

Harry Boscoe (talk|edits) said:

5 February 2011
Election? What election?

Captcook (talk|edits) said:

5 February 2011
The election to treat debt secured by your principal residence as not secured by your principal residence. Reading my post again, it is not necessarily an election to treat it as investment interest.

Harry Boscoe (talk|edits) said:

5 February 2011
Oh, *that* election....

Death&Taxes (talk|edits) said:

5 February 2011
I knew Harry would find this discussion eventually, so I saved my fingers from typing the same thought. Originally I assumed he was putting the money in his mattress, but now I see he might deduct interest on 100K as equity interest, and the rest as investment interest. That brings up the question, can he bifurcate the loan?

I wouldn't try but would take it as investment interest. Of course, in today's world perhaps he is paying 3-4% and earning 1-2%, which leaves him piling up unused investment interest deductions unless he has other investment income.

Harry Boscoe (talk|edits) said:

5 February 2011
Bifurcate? Why would he need to bifurcate?

You just like the word cuz it sounds kinky. Bifurcate, bifurcate, bifurcate...

Death&Taxes (talk|edits) said:

5 February 2011
dance to the music.

One reason to deduct it all as investment interest is that the equity interest would not be deductible for AMT, if he is subject to that tax.

Harry Boscoe (talk|edits) said:

5 February 2011
While we're checking off the "what-ifs" shouldn't we also consider the possibility that the taxpayer doesn't itemize? How about the possibility that he's got a $1.5M mortgage on his vacation place at the beach? How about the possibility that this guy's got $200,000 of fully taxable bond interest on his Schedule B?

Let's stipulate that every appropriate simplifying assumption has been made. We can argue about what those simplifying assumptions are later.

Now what are his options for the tax treatment of the interest he's paying on this non-acquisition mortgage on his principal residence the proceeds of which he's holding in a savings account?

Maughact (talk|edits) said:

5 February 2011
Taxpayer does itemize. He has enough investment income to cover the interest expense for the 1/2 of the loan. He is not subject to AMT this year.

The more research I did on this subject, the more I conclude that he can deduct the interest on the part of the loan that is not allowable home equity as investment interest expense since he has the money invested in a savings account. This saved him about $500 in taxes. I am very happy that I posted the question to this site. Thank you.

Harry Boscoe (talk|edits) said:

5 February 2011
Well done, Mau!

Death&Taxes (talk|edits) said:

5 February 2011
You should read the esteemed Riley's opinion here:

Discussion: Election Not to Treat Debt as Secured by Qualified Residence

Captcook (talk|edits) said:

5 February 2011
Interesting, D&T. I read the reg again and it doesn't say you can't elect a portion of any given debt to be unsecured rather than an "all or nothing" by total loan balance, which appears to be Riley's assertion. Of course, the reg doesn't say you CAN allocate proceeds from one particular loan either.

Gray area in tax law...weird.

Harry Boscoe (talk|edits) said:

5 February 2011
D&T, can you point out how the (o)(5) election and "bifurcation" apply to this OP's scenario?

Were you in class last summer? Were you daydreaming again? Did you take the midterm exam?

Death&Taxes (talk|edits) said:

5 February 2011
In this situation, Harry, the (o)(5) election is the safe course because unused Investment Interest only vanishes at death and will be there after the loan is paid off. Eventually it will be used. On the other hand, using tracing rules and bifurcating the debt in two, if the client is audited and if Riley is correct, half the interest is lost forever.

Had he taken two equity loans, each for 100K, the issue would not arise.

Harry Boscoe (talk|edits) said:

5 February 2011
Oh, D&T, I'm sorry to remind you, you were sound asleep in summer school last year...

IMO, doing *nothing* here - no election, no "bifurcation" - the interest on the first $100K is fully deductible as qualified residence interest (home equity type), and the interest on the second $100K is deductible, as investment interest expense, subject to the Section 163(d) limitations.

That sounds like a very good - maybe the best - result, no?

Death&Taxes (talk|edits) said:

5 February 2011
I think the first duty of the tax physician is to do no harm; I read the summer discussions again and believe there was no clear cut winner. I am not the one bifurcating the loan, but believe that is what happens when you split it or, to put it more clearly, you follow the money.

There might be a 200,000 loan here at rates that could be lower than 4%. $8,000/2 of interest deduction will be at stake should it come up in audit, or at most $1,400 of tax for one year. Hate to put the client in position where even if he wins, he pays me his tax savings to represent him.

As Cook says above, it is unclear what the Regs mean, but after the Supremes handed down Mayo and denied the FICA refund on the basis of accepting IRS regs, it will make arguing more difficult.

Harry Boscoe (talk|edits) said:

5 February 2011
And what deduction would the IRS agent disallow, pray tell?

Death&Taxes (talk|edits) said:

5 February 2011
He will cite 1.163-8T(m)(3) and to quote Dave Fogel "Treas. Reg. §1.163-8T(m)(3) provides that qualified residence interest is allowable as a deduction without regard to the loan proceeds tracing rules of §1.163-8T. That means that if the loan satisfies the requirements of IRC §163(h)(3), then the interest is deductible as qualified residence interest regardless of the purpose for which the loan proceeds were used."

Or yours truly from the same famous discussion "1.163-8T(e) would normally cover this refinance, but later in that same regulation we get 1.163-8T(m)(3) which sends us to the definition given in Section 163(h)(3), ........

He will allow the home equity interest limit, but not the interest on the extra 100K.

Now we might as well reprint the entire discussion, or at least link it.

Discussion: Summer school midterm exam question...

I am not saying he is right or wrong but when there is a scenario where two roads lead to possible tax deductibility, one smooth but possibly longer, and the other a bit rockier if IRS comes calling, I know what I would choose. I might be more amenable to your position if these were backhoes!

Harry Boscoe (talk|edits) said:

5 February 2011
If the (o)(5) election is not made and the taxpayer deducts half the interest expense as home mortgage interest and half as investment interest expense, where does IRS insert the crowbar to unseat *either* of these deductions?

Which of these two interest deductions has *any* risk of disallowance?

Harry Boscoe (talk|edits) said:

5 February 2011
[A parenthetical aside: No one needs to read the thread from last year, Thank Heavens, since the (o)(5) election and "bifurcation", which are the issues in that thread, play no role in Mau's client's choice to deduct his home equity interest as home equity interest and his investment interest as investment interest. Truly. HB]

Death&Taxes (talk|edits) said:

5 February 2011
Because of the word 'any' in Sec. 163(h)(3)(C)(i)

" In general. The term “home equity indebtedness” means any indebtedness (other than acquisition indebtedness) secured by a qualified residence"

Harry Boscoe (talk|edits) said:

5 February 2011
Do you just skip over the "shall not exceed $100,000" part of the definition [Section 163(h)(3)(C)(ii)] and make pretend it's not there?

Death&Taxes (talk|edits) said:

5 February 2011
"The aggregate amount treated as acquisition indebtedness for any period shall not exceed $1,000,000" Same wording but amounts over the 1M can't be anything but disallowed personal interest.

Harry Boscoe (talk|edits) said:

6 February 2011
"...but amounts over the 1M can't be anything but disallowed personal interest."

...and they can't be investment interest?
...and they can't be trade or business interest?
...and they can't be interest on a rental property

You know you're saying that tracing no longer exists? Have you been sipping the firewater again?

I'm gonna do the almost-unthinkable and pull up a copy of Pub 936.

Death&Taxes (talk|edits) said:

6 February 2011
Remember, the 1M defines the limit on acquistion debt.

If Vito lends me 50,000 and secures it with my kneecap, I can trace that money to my heart's content.

Do remember, my friend, you asked me to be the IRS Revenue Agent, and I want you to spend your client's hard earned money on your fees. I want him to say, 'if I'd only listened to that D & T and taken 100,000K in equity loan from TD Bank, and a second 100,000K from Wachovia as another equity loan, I could make that blasted election on one of them and I wouldn't have to pay Harry his fee for printing Publication 936.'

As the person posting here, I am not saying I believe all this stuff, but depending on the point spread, I might bet on IRS.

Harry Boscoe (talk|edits) said:

6 February 2011
So you can be the IRS Agent. Just complete this explanation: "Of the $8,000 interest expense claimed on Schedule A, $_______ is disallowed because ... ...."

Kevin: Can you find a YouTube of the classic two mountain goats/sheep/rams whatever that slam their heads together over and over and over and over and over and over...?

Death&Taxes (talk|edits) said:

6 February 2011
"Home equity interest is always Home Equity Interest (except when the Commissioner allows you to include it as acquisition interest) because of 1.163-8T(m)(3), unless you make that election. We paid someone to write that election and here you go wasting the taxpayers' money. If you want to borrow unsecured funds from Vito or the bank, I'll make you trace those down to every farthing, but this!"

One thing I find is that back in 1986 Congress realized people would be sucking equity out of their houses, and in TRA86 provided only two tax deductible reasons: education and medical. Now this is old history and obsolete, but it was their intent, and that election must have had something to do with finding a legal way around this.

You can have the last word for today....I'm going to watch some Law & Order from Season 8 [gave wife and self Seasons 5-8 as a Christmas Gift]

Harry Boscoe (talk|edits) said:

6 February 2011
A tout à l'heure, mon ami.

DgR (talk|edits) said:

7 February 2011
Another issue unresolved.

Harry Boscoe (talk|edits) said:

7 February 2011
"Another issue unresolved."

Au contraire, mon ami.

I have now been reduced to quoting from IRS publications, and I hang my head in shame for that. But I'll hang my hat on what Pub 936 says about the deduction of interest on home mortgage debt beyond the dollar limits.

Ready?

"You cannot deduct the amount of interest on line 13 as home mortgage interest. If you did not use any of the proceeds of any mortgage included on line 9 of the worksheet for business, investment, or other deductible activities, then all the interest on line 13 is personal interest." emphasis added

I would suggest that this completely defeats, eviscerates, lets the air out of, seriously cripples, somewhat counters, offers another conclusion to, any argument that "home mortgage interest" that's "over the limit" is "always" personal interest.

Anyone?

EZTAX (talk|edits) said:

7 February 2011
Go Harry! Have followed this discussion - in one form or antoher - on this site for years. The pub is clear, the code is not - I say you have to do what you have to do and in this case I am going to default to the publications since the code is so ambiguous.

Thanks for fighting the good fight.


Fsteincpa (talk|edits) said:

28 April 2011

On-point article from JOA: IRS Expands Rules on Deductible Home-Equity Debt, which also references Rev. Rul. 2010-25.

info under copyright has been removed in accordance w/TA's copyright policies. The link above goes to the same content.

Taxea (talk|edits) said:

29 April 2011
I got this today from Accountants World News. It is what Fsteincpa is talking about.

Forum Mgmt: is this what we cannot post?

http://www.journalofaccountancy.com/Issues/2011/May/20113910.htm

Trillium (talk|edits) said:

29 April 2011
Laura, if you're interested in more info on TaxAlmanac's copyright policies, the best place to start is in the Website Use and Contribution Terms, which is linked in the upper right corner of every page on TA. There's also some more explanation at the very bottom of this help page on adding content, including:
Do not violate copyrights. To be safe, do not copy more than a couple of sentences of text from anywhere, and document any references you do use. You can copy material that you are sure is in the public domain, but even for public domain material you should still document your source. Also note that most Web pages are not in the public domain.

What Fred had originally posted, and what was removed, was the full content of the JOA article. That content is copyrighted by the JOA, and therefore under both their terms and TA's, cannot be reposted here. But he had also posted a link to the article, and that is fine - it's not a copyright infringement, and since it doesn't link to his own website, it's clearly not an issue with TA's limitations on self-linking. And you're also fine in posting the link to the article a second time).

Fsteincpa (talk|edits) said:

29 April 2011
Thank you there Trillium. Always taking care of me. what kind of permission would I need from the powers that be at the Journal to be allowed to post entire article?

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