Home Equity Debt Interest Deduction Limitations

One of the current IRS audit initiatives is checking to see if taxpayers are deducting too much equity debt interest.  Generally, taxpayers are allowed to deduct the interest on up to one million dollars of acquisition debt and the interest on up to $100,000 of equity debt.  Over the past few years, taxpayers have frequently exceeded the debt limits and have failed to adjust their interest deduction accordingly.

The best way to explain this interest deduction limitation is by example.  Let’s assume that you have never refinanced the original loan that was used to purchase the home and that the acquisition debt is less than one million dollars.  However, you have a line of credit on the home and the debt on that line of credit is treated as equity debt.  If the balance on that line of credit is $120,000, then you have exceeded the equity debt limitation and only 83.33% ($100,000/$120,000) of the equity line interest is deductible as home mortgage interest on Schedule A.  The balance is not deductible unless you can trace the use of the funds to either investment or business use.  If traceable to investments, the amount traceable would be deductible as investment interest, which is also deducted on Schedule A but is limited to an amount equal to your net investment income (investment income less investment expenses).  If the excess was used for business, you could deduct the excess on the appropriate business schedule.  Alternatively, you could elect to treat the equity line as not secured by the home, which would require the interest on the entire loan to be traced to its use and deducted on the appropriate schedule.  However, none could be traced back to the home itself. 

Using the unsecured election can have unexpected results in the current and future years.  You should use that election only after consulting with this office.

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