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November 2014 Tip of the Month

DON'T BE SO QUICK TO PAY CASH FOR YOUR NEW HOME INSTEAD OF A MORTGAGE - CALL YOUR ACCOUNTANT FIRST!

Nope, this alert is not about financial statements, accounting issues or valuation studies but we do think you should pass it along to friends, co-workers and even your mortgage brokers/bankers.

Okay, this is the third time in the last week an Abo and Company client was reprimanded for not calling us first, so we thought it worthy of an email alert (you know who you are).

All three individuals just did not realize that Uncle Sam gives them but 90 days to put a mortgage on their home and still deduct the interest expense as qualified "acquisition indebtedness".  

First, let's talk about the qualified residence interest rules.

Taxpayers can claim an itemized tax deduction on their federal income tax return for the interest on up to $1,000,000 of acquisition debt.  Acquisition debt is defined as mortgage debt the proceeds, of which are used to buy, construct, or substantially improve the taxpayer's first or second residence.   Unfortunately, there has also been a lot of bad advice out there.  Individuals have been advised to cash-out finance their primary residence to pay off consumer or student loan debt by converting this either partially or totally non-deductible interest to mortgage interest.  This fails the "buy, construct or substantially improve" requirement.

They also can have up to another $100,000 of home equity debt (which is other than acquisition debt) on a first or second residence. Therefore, interest on a total of up to $1,100,000 of home mortgage debt can potentially be treated as deductible qualified residence interest.  

It's good to know that a qualified residence includes a taxpayer's principal residence plus one additional personal residence owned by that taxpayer. If you own two or more additional residences, you can designate which one you are treating as your second residence for each tax year.  For this qualified residence mortgage interest deduction, a qualified home includes boat, mobile home, house trailer or similar property that has sleeping, cooking and toilet facilities.  However, local law has to permit such use.  We've been advised that a houseboat would not qualify if moored at a marina where overnight sleeping is prohibited.

The rub?


Well, you should know that the federal tax law only allows you a 90 day window to place a mortgage on the qualifying residence from the time you buy, construct or substantially improve that home.  After that, any other mortgage you place on the property will be considered "home equity indebtedness". If you are subject to the dreaded "Alternative Minimum Tax" (AMT), you will NOT be able to deduct any of the interest expense on that new mortgage. Even if you aren't subject to AMT, you still can only deduct interest expense on up to $100,000 of that new mortgage whereas if it were considered "acquisition debt", you could deduct the interest expense on up to $1,000,000 of the mortgage (even if you are subject to AMT).  By the way, generally, as long as it's "qualified acquisition debt", your use of the actual mortgage proceeds doesn't enter the picture (i.e. you can use it to pay for a car or other consumer purchases, fund college tuition, travel, repay other loans, etc.).  Refinancing of an acquisition debt is considered acquisition debt to the extent it does not exceed the principal outstanding on the loan immediately before the refinancing.

Saying it again....any mortgage placed on the home after 90 days of the purchase, unless the funds are used for a home improvement, will be considered the lower grade of "home equity debt". 


There is quite a number of non-tax considerations we believe you should consider (such as we hear from our mortgage broker/banker colleagues touting to lock in the historically low longer term interest rates).  

In the final analysis, how much and when to borrow depends on the terms of the alternative arrangements that are available, economic and financial issues that are specific to you, and the after tax results attained by use of one or the other choice.  We at Abo and Company just hate possibly having to say to clients and friends "...this is what you could have done or should have done."