Cash Flow Planning for Life - Helping you reach your personal & professional financial goals.

Cash Flow Planning for Life

Helping you reach your personal & professional financial goals.

4: What You Need to Know About Mortgage Interest

Posted by Mark On January 18th

What You Need to Know About Mortgage Interest

This is the fourth installment of Tax Deductions & You: What You Need to Know which can also be downloaded from our free eBook library.

Although most people understand that mortgage interest is deductible, many people may not be aware that there are certain situations in which it actually creates a greater savings not to claim a deduction as mortgage interest.

Under Treasury Regulation 1.163-10T(o) a taxpayer may elect to treat mortgage debt as not secured by a qualified residence.

Once this election is made, it is effective for all subsequent years and can only be revoked with IRS permission. The advantage of this election is if a taxpayer has allowable mortgage interest that is limited by the $1,000,000 or $100,000 rules on indebtedness.

Let’s say you have a home equity loan that is used for a business. The interest deducted on a business return or “Schedule C”, in most cases, will create a greater tax savings than if the interest was deducted as mortgage interest.

Here’s an example:

A taxpayer takes out a $180,000 home equity loan to start a business. The interest on this loan will be limited to $100,000 in loan value and deducted on schedule A. This may be further limited depending on a taxpayer’s Adjusted Gross Income. If you make the above election, you will be able to deduct the full amount of the interest from business income. This will reduce Adjusted Gross Income, which in turn will reduce any applicable AGI limitation, further adding to the cash savings.

Internal Revenue Code 266 is an annual election made to capitalize carrying cost (i.e. real estate taxes, interest, maintenance cost) into the basis of vacant lots of real estate.

This election is only available for vacant property. If you have real estate that includes any type of structure, you will need to treat this as a rental property or investment property. Therefore, expenses need to be deducted on the appropriate schedule A or E.

This election does not create an immediate tax savings. However, if you are currently caught up in the Alternative Minimum Tax or have no taxable income, then real estate taxes and miscellaneous itemized deduction are of no benefit to you in the current year.

The tax savings will come when the property is sold, as cost basis in the property will be increased by the capitalized expenses.

First Time Homebuyers
If a first time home buyer purchases a home in November or December of a given year, he or she may not generate enough deductible interest and points to exceed their standard deduction. By electing to amortize the points over the life of the loan, the deduction may be small each year. However, it will generate more cash flow than deducting the points in a year that they have no benefit.

By reviewing your option to deduct points paid in the year paid or amortize them over the life of the mortgage, you could create a cash flow savings over time.

One common misunderstanding, when it comes to refinancing a current mortgage, is that all of the interest is deductible. This may not be the case. Any dollar over the existing balance, at time of the refinance, is conTax Deductions and You - What You Need to Knowsidered home equity debt unless it is used to improve the existing home. Remember, only $100,000 of home equity debt interest is deductible.

As with most areas of the Tax Code reviewing and planning for interest paid should be an annual conversation you have with your tax professional. As you have read above there are options and planning opportunities for all types of interest.

To discuss mortgage interest in more detail, please come see me at Makara & Associates, a Naples CPA firm. I would be happy to review your situation. We offer many accounting services to meet your needs including; cash flow planning, social security planning, and so much more. As always, if you have any questions, concerns or comments, please feel free to contact me online or give me a call directly at (239) 384-9688. Also, don’t forget to connect with Makara & Associates on Facebook.

– Mark


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