Mixed Mortgage Interest

[Diane]

From a client:

I just refinanced my house which had a principle balance of 85,000. My new loan is for $270,000 at 4.5% for 30 years. The interest per month is about $1012 which will come to $12000 per year. I am not allowed to deduct all that interest? Of the 270,000 borrowed 85000 paid back the old loan, 57000 paid back a home equity line that was deductible, and 5000 went to closing costs. 123000 went into the bank and might be used for a real estate purchase or home improvement but I am not sure when. How much of my interest is deductible?

Also In two or three years if I move out of my primary residence and consider it a rental property all the mortgage interest then becomes deductible?

How much interest is deductible? Schedule A, then Schedule E if converted to a rental.

Diane

[sschillercpa]

This topic can be confusing. You will probably have interest that is partially deductible and partially non-deductible, and some that needs to be added back when calculating the AMT. You may be able to allocate some of the interest to investment interest, depending on what the client did with the funds that were borrowed.

You need to start by finding out what the "acquisition" indebtedness is. The acquisition indebtedness is the original amount of the loan taken out when the property was purchased (this may be both a first and second loan), reduce it by principal repayments, and then you can increase it by the costs of improvements made to the property.

On Schedule A you can deduct interest paid on the acquisition indebtedness, plus interest paid on up to $100K of home equity indebtedness.

On Form 6251, line 4, you will have to make an adjustment for the home equity indebtedness. See page 2 of the instructions to Form 6251 and the worksheet they provide.

Regarding converting the home to a rental, I think all the interest would be deductible on Schedule E, but I'm not certain. Of course the resulting loss, if there is one, may not be fully deductible because of personal usage and passive activity rules, etc.

I hope this helps.

- Stephen

[Diane]

Thanks very much. You did help a lot. Trying to make sense of the different rules regarding interest, especially in this case, made my head hurt.

Again, Thank You

Diane