It is The Meredith Mortgage Team’s intent to keep you informed and share relevant, current information that will contribute to your future success. 

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If you decide to pay cash for a home, there could be a hiccup later if you decide to refinance in order to pull cash out. As long as you itemize, home mortgage interest is tax deductible up to $1.1M. What many people do not realize is that, according to the Internal Revenue Code, there are actually two types of mortgage interest: acquisition indebtedness and home equity indebtedness.

The first type refers to any kind of borrowing that is incurred to acquire, build or substantially improve a taxpayer’s residence. The limit is $1.0M for deductibility purposes. You can buy the most expensive house that you desire, of course, but you only get a tax break on interest related to the $1M of debt — acquisition indebtedness. Note that the $1M restriction applies to the amount of money borrowed, payments aside. Whether the loan is a one year deal with sky high payments or a fully amortized 30-year fixed note, the interest is fully deductible up to the $1M limitation — the amount of debt originally incurred to buy the property (acquisition indebtedness). The $1M limitation includes both the taxpayer’s primary residence and vacation home, the total acquisition indebtedness not to exceed $1M.

The second type of mortgage interest defined by the Internal Revenue Code is known as home equity indebtedness. This category includes any home debt that does not fit into the first category — a home equity line of credit or the cash out portion of a refinance, for example. The interest on home equity indebtedness is only deductible up to $100,000 of debt principal.

If you buy a home for $1.5M and you put down $500k, you have a note for $1M. All of your mortgage interest is tax deductible in this case. But if you suddenly need access to $200k and take out a HELOC to get it, you have exceeded the total mortgage interest deductibility limitation of $1.1M. You can still take out the loan, bringing your total debt on the home to $1.2M, but you will only be able to deduct mortgage interest related to debt principal of $1.1M.

If you pay cash for a home, your acquisition indebtedness is zero. If you pay cash for a $500,000 house, you have no acquisition indebtedness at all. Let’s pretend that you later decide to pull all the equity out of your home, and you find a lender willing to give you a 100% loan-to-value loan. You can take that $500,000 and do whatever you want with it, but only the interest on the first $100,000 will be eligible for the home interest tax deduction. That is a very big downside to paying cash for a home. If you do not plan to pull more than $100k out of equity after paying cash for your home, it is a non-issue.

It is also important to note that the total of acquisition indebtedness and home equity indebtedness ($1.1M) cannot exceed the value of the home when the loan is incurred. Interest related to debt principal above the value of the home is considered non-deductible. Another caveat is that home equity indebtedness must be added back to income for those subject to Alternative Minimum Tax (AMT). That means that the interest related to home equity indebtedness is not deductible at all for those subject to AMT. The good news is: if a mortgage was first deemed acquisition indebtedness, any refinancing of that mortgage will continue to be considered acquisition indebtedness. However, a fully amortizing loan does reduce your acquisition indebtedness.

While tax professionals should know the ins and outs of what is and what is not tax deductible, many borrowers do not think to consult their tax adviser prior to purchasing a home. When it comes to how large a down payment to make, they are more likely to consult with their spouse. Unfortunately, the equity in your house is not an inexhaustible store of deductible mortgage interest, so large down payments should be considered carefully.

This issue is a value added reason to touch base with your clients and referral partners, as most people are unaware of this.

Should you wish to sit down with us for 10 minutes; we can help further clarify if need be.  We are very busy but you are our priority, so give us a call and we can set up a one on one with you.

To Your Success,

Kathleen and Erin

The Meredith Mortgage Team

“We Will Always Have Your Best  

  Interest In Mind”   

 

 

Erin & Kathleen

The Bay Area’s Premier

Mortgage Banker and Broker

 

Erin Direct: 925.918.0585

Kathleen Direct: 925.735.6621

meredithteam@rockcliff.com

kmeredith@cmgmortgage.com

emeredith@cmgmortgage.com

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