In order to maximize your mortgage interest deduction, you
need to first get your house in order. Many people
recognize that the deduction for home mortgage interest is
one of the most potent tax breaks available today. Most
people are surprised at how complex and full of pitfalls
the mortgage interest deduction rules really are and more
are surprised about how big of a role their house plays in
their wealth strategy.
How to get your house in order depends on how your loan
will be categorized.
CATEGORY 1: Did you obtain your loan to buy your residence?
Usually the interest paid on a loan if the proceeds are
used to buy or build a residence (a main home and one
vacation home) is fully deductible. This type of financing
is called acquisition debt. There are two important rules
to remember:
1. The acquisition debt must be less than $1.1 million in
order for all interest to be deductible
2. The acquisition debt must be secured by your home
If your acquisition debt exceeds the $1.1 million limit,
then your mortgage interest deduction is limited to the
interest on $1.1 million.
In most situations, any points you pay to the lender in the
year you get a mortgage loan to buy your main residence are
fully deductible.
How to get your house in order for Category 1:
If your acquisition debt exceeds the limit, then taking
advantage of other tax deductions will be even more
important in your tax strategy.
For example, using a portion of your home as a home office
will maximize your deductions because the home office rules
do not have a maximum acquisition debt rule.
If you own business or real estate investments, you may
consider getting a loan within the business or real estate
investment to provide you with cash to pay down or
refinance your acquisition debt. This will lower your
acquisition debt. Even though your overall debt balance
between the acquisition debt and the business or real
estate investment debt is the same, this strategy maximizes
your interest deduction by:
Reducing the amount of acquisition debt, which in this
example is over the $1.1 million threshold so the interest
on the excess is non-deductible.
Increasing your business or real estate investment debt,
the interest on which is usually deductible. The interest
may be currently deductible or deductible in future. Both
are a better result than non-deductible.
You may also want to consider this "debt shifting" strategy
if your itemized deductions are subject to limitations,
which turns a portion of your deductible mortgage interest
into a non-deductible expense.
CATEGORY 2: Did you refinance your loan to remodel?
If you refinance your existing loan to pay for an expansion
or remodeling of your home, all of the interest you pay on
the new loan usually will be deductible as acquisition debt
and subject to the same rules in Category 1.
Follow the same tips to get your house in order as Category
1.
CATEGORY 3: Did you refinance for better rates or terms?
If you pay off the loan you got to buy your home with a new
loan carrying a lower rate of interest or more favorable
terms overall, all of your interest on the loan usually
will be deductible as acquisition debt and subject to the
same rules in Category 1 - EXCEPT any points you pay on the
new loan will be deductible over the loan term and not all
at once in the year you refinance.
Follow the same tips to get your house in order as Category
1.
CATEGORY 4: Did you refinance to raise cash for a personal
asset or expense?
Interest paid on a consumer loan to pay for a personal
asset or expense, such as buying a new car, or paying
medical expenses, is not deductible. However, you can
transform that non-deductible expense into fully deductible
interest if you use your home as collateral for the loan,
and the total amount of such home-equity loan doesn't
exceed $100,000. The loan can be a first mortgage, a second
mortgage, or a home equity type loan.
How to get your house in order for Category 4:
You will want to make sure the debt related to the personal
asset or expense doesn't exceed $100,000. If the debt does
exceed this limit, then your interest deduction is limited.
Be sure to keep track of the loan balance related to the
personal asset or expense and provide that information to
your tax preparer.
CATEGORY 5: Did you refinance to raise cash for an
investment or business asset or expense?
Interest paid on a loan to pay for an investment or
business asset or expense is usually deductible as an
investment or business expense. This portion of the loan
is not considered acquisition debt.
How to get your house in order for Category 5:
In most cases, you will need to "trace" the portion of the
loan that was used for acquisition debt and the portion
used for investment or business assets or expenses. This
enables you to properly allocate the portion of interest
that is related to your home and the portion that is
related to the investment or business. Keeping proper
documentation on this is key because in many cases a
greater interest deduction is taken.
Proper documentation includes proof of the portion that was
used towards the business or real estate investment or
expense, the calculation of interest on that portion, and
how the business or real estate investment paid its portion
of the interest. Be sure to provide this information to
your tax preparer.
As I mentioned at the beginning of this article, many
people are surprised at how complex and full of pitfalls
the mortgage interest deduction rules really are and even
more are surprised about how big of a role their house
plays in their wealth strategy. This all means opportunity
- opportunity to increase your overall interest deduction
and opportunity to turn taxes into wealth to add velocity
to your wealth strategy.
----------------------------------------------------
Tom Wheelwright is not only the founder and CEO of
Provision, but he is the creative force behind Provision
Wealth Strategists. In addition to his management
responsibilities, Tom likes to coach clients on wealth,
business, and tax strategies. Along with his frequent
seminars on these strategies, Tom is an adjunct professor
in the Masters of Tax program at Arizona State University.
For more information, visit
http://www.provisionwealth.com.com .
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