Debt, Housing, Taxes

Rules You May Not Know About When You Use Your Home As An ATM

Using a home as an ATM

The state of California recently reviewed a sample of state tax returns which claimed large mortgage interest deductions and found that 75% of the tax returns had claimed excessive interest deductions. There are rules that limit how much interest you can deduct for your mortgage and other monies borrowed against your house. However, historically, only the extremely wealthy would run up against these rules. Today with so much home equity, particularly in some of the more expensive coastal areas, many people are running afoul of the rules and don’t even realize it.

Most notable is that you can only deduct the interest on the first $100,000 that you borrow against your house for things other than home improvements. Also, when it comes to Alternative Minimum Tax (AMT), home equity interest deductions are completely disallowed. The state of California is cracking down on these deductions and is starting to do a large amount of audits on taxpayers with large mortgage interest deductions. It is likely that other states and the Federal government will follow suit, so it is a good idea to make sure you are aware of the rules. If you have been using your house as an ATM, that is when you really run into trouble. Here is a quick rundown of the rules when it comes to mortgage deductions.

In order to deduct home mortgage interest, the interest must be either acquisition debt or equity debt. If you borrow money against your home for investments or for business, you may be able to deduct the interest accordingly, as investment or business interest. It does get tricky and this method generally will be best if you borrow money solely for one purpose.

When it comes to borrowing money against a home for a mixture of uses, it can start to get really ugly. If nothing else, you need to keep the monies completely separate, and track the interest separately. Overall this is just meant to be a mention that this exists and is far beyond the scope of this article.

For purposes of this article, I will focus on what you can deduct on your Schedule A as home mortgage interest. The first type of mortgage interest I mentioned is acquisition debt. For mortgages taken out on or before October 13, 1987, the rules are a little different (this was the date of the last major change when it comes to home mortgage interest rules), but for the most part these mortgages will pass without meeting all the new rules.

For mortgages taken out after October 13, 1987, home acquisition debt is any money borrowed against a home to buy, build or improve the home, for a total amount of $1 million or less. Basically if the total of all your outstanding loans, secured against your home, to buy, build or improve said home, and the total is $1 million or less, then the entire interest is tax-deductible.

As a bonus, you can actually use acquisition indebtedness to cover a second home as well. A second home could include a boat or a trailer if it has a toilet and cooking facilities. So for example, you could take out a $1,000,000 mortgage to pay for a house and a motor home, and still be able to deduct all of the interest.

In reality, not very many of us are going to come up against the above mentioned threshold, but it is the home equity portion that is getting many taxpayers into trouble. Qualifying equity debt includes any mortgage taken out after October 13, 1987 that is not used to buy, build or improve a home. Only the interest paid on the first $100,000 of this debt is tax-deductible as regular mortgage interest. Anything beyond that is pretty much treated as non-deductible consumer debt.

Of course you read in the papers time and time again taxpayers are borrowing far more than $100,000 against their home for cars and vacations and other fancy things. This is common in areas like California where so many middle-wage earners have so much equity in their house which they can burn through.

Time and time again I see claims that is a great idea to borrow against your house for cars and to pay off consumer debts, because the interest is low and tax-deductible. This is the case for most people, but too many people are returning to their house as a constant source of cash, and over time don’t even realize their mortgage interest above a point is no longer even tax-deductible.

Also, keep in mind that these are the rules for married taxpayer. For single taxpayers, acquisition indebtedness caps at $500,000 and home equity caps at $50,000, or in other words these are half of the amounts stated above for married taxpayers filing jointly.

Overall, Turbo Tax and other similar programs are really not equipped to help you out in this area, as it does get complex. If you are concerned that you may run up against these rules, I suggest you meet with a CPA to make sure you are filing your tax returns correctly and to help you figure how much of your interest is truly tax deductible. IRS Publication 936 – Home Mortgage Interest Deduction – is also a wonderful resource for studying up on the home mortgage interest rules and how they apply to you.

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