By Arden Dale
Some people who owe more than $1 million on their homes are coming under the microscope at the Internal Revenue Service over how much of their mortgage interest they can deduct on their tax returns.
The number of taxpayers involved could be in the tens of thousands because in some parts of the country, many homes sell for more than $1 million and even a buyer who puts down 20% or 30% may need to borrow. The amount of interest at stake is substantial, in some cases as much as $50,000 to $60,000 on a $1.1 million mortgage.
The IRS didn’t comment, but the scrutiny follows a period of confusion by taxpayers, advisers and even some IRS agents about how much interest can be deducted, based on what kind of debt the homeowner holds. Tax rules distinguish between two kinds of home debt. There is home acquisition debt, which is a loan used to acquire, construct or substantially improve a qualified home, and is secured by the home. Then there is home equity debt, which is any other kind of loan that is also secured by the home.
Some tax advisers were telling clients it was acceptable to deduct all interest on a single mortgage of up to $1.1 million. Others contended that the limit for mortgages was $1 million, but they could also deduct interest on another $100,000 in a home equity loan, according to Melissa Labant, tax technical manager at the American Institute of Certified Public Accountants.
IRS guidance last June helped set the rules straight. The agency said acquisition loans over $1 million may also qualify as home equity indebtedness. Now, says Labant, it is clear the taxpayer can deduct interest on the full $1.1 million, even if he has only one loan. The development, she adds, is “good news for taxpayers.”
The rules can get “particularly complex for a mere mortal” when various refinancings get thrown into the mix, and the taxpayer owns several homes, say a house in upstate New York and a condominium in New York, according to David A. Lifson, a certified public accountant at Crowe Horwath LLP in New York, who has clients caught up in these mini-audits. In past six months, he says, the Internal Revenue Service has notified many people that it is looking at their mortgage interest write-offs.
Tax rules generally allow deductions on a first and second home, but not a third or more.
Readers, have you been confused by how much of a deduction you can take?