Mortgage Interest and Tax Considerations
During the last several years, the federal government has phased out the
interest deductions for personal investments, including auto loans and credit card debt.
Actually, 1990, represented the last year any consumer interest could be deducted.
However, interest on mortgage indebtedness, with certain limitations, is still fully
deductible.
According to present tax law, the amount of mortgage debt upon which
interest can be deducted is calculated according to two parameters: Acquisition Debt
and Home Equity Debt.
Acquisition Debt is defined as indebtedness which was incurred
for the purchase, construction, or substantial improvement of a primary or secondary
residence and which is d by the subject property. Full interest deduction is allowed
for all acquisition debt as long as the debt does not exceed $1,000,000 and as long as the
total debt does not exceed the property's fair market vale.
Home Equity Debt refers to debt which is d by a primary or
second home which was/is used for any purpose besides the purchase, construction or
improvement of the property. There are no limitations as to the use of home equity debt
(unless the proceeds are to be used to generate tax-free income.) The proceeds of the loan
can be used for any reason including the payoff of personal debt, the purchase of rental
properties, automobiles, boats, personal investments or whatever... Complete interest
deduction is allowed for home equity debt with a combined total of no more than $100,000.
Therefore, the maximum combined loan amount which upon which interest will be fully
deductible is $1,100,000.
Those individuals who refinanced their properties in previous years have
an added bonus. All debt which was d by a qualifying property on or before October
13, 1987 is treated as acquisition debt regardless of the purpose of the loan and
irrespective of the original purchase price. Therefore, these individuals can still draw
out of their remaining equity an additional $100,000 for virtually any purpose which they
desire.
In order to tap the equity in a qualifying home, utilization of a second
or third mortgage is not the only option. A full refinance of the existing lien(s) with
additional cash out is allowed. Of course, the resulting loan will be composed of both
acquisition debt, representing the amount of the mortgage(s) paid off, and home equity
debt, representing the balance of funds obtained. If a major portion of the funds which
are received is for the express purpose of major home improvements, these funds will be
allocated to acquisition debt.
For tax purposes, the definition of a "home" is not limited to
a house or condominium. It may be a mobile home, a cooperative unit, a motor home or even
a boat. However, it must supply basic living accommodations, including sleeping space,
cooking facilities and a toilet.
There are several ways to maximize the tax advantages of borrowed funds.
First, when purchasing a residence it is usually best to take out the largest loan
possible and decrease the amount of the down payment. Especially for first time buyers,
there may be additional cash needs which can be successfully projected over the short
term. Moving into a new home usually requires substantial expenses beyond those required
for closing the transaction. Furnishings often must be purchased, minor repairs required,
pictures and drapes obtained and numerous household items are usually desired. If personal
loans are obtained for these items, not only will there be little or no deduction allowed,
but the interest rates charged will, unquestionably, be substantially higher than on a
mortgage loan.
For those who are selling their old residences and moving up, it is most
advantageous to first consider paying off all personal debt, including charge cards,
automobile loans and other such items and then look at paying down or paying off any loans
on bare land or stock margin accounts. As previously stated, these accounts supply no tax
advantages and have higher interest costs than mortgage debt.
The present tax laws have supplied homeowners with several
opportunities, yet there are pitfalls which must be avoided. Overall investment strategies
must reflect the new tax structures. This may be the most opportune time to buy or
refinance. For additional information, or to discuss specific circumstances, please call.
We are pleased to assist you in any way possible.
(The foregoing was gathered from sources thought to be reliable and
thorough. For major decisions, it is suggested that a competent tax attorney or certified
public accountant be consulted.)
Written by Rick Keltner - Owner/Broker, Mortgage Resources
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