My client built a second house on his lot. Both buildings were used as the family residence (let's call it a compound). He financed the construction of the second building by taking out a home equity loan on that property. So I have been deducting all interest as backed by a home for acquiring and constructing a home. Two years later, comes the economic downturn and he wants to rent out the second house. Assuming he does not refinance, would you deduct the interest applicable to the second building which will now bve rental and where would you deduct the interest, Schedule A or E?
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I would deduct it on "E"
Since that was the use of the money. Unless part of the mortgage was used for another purpose in which case I would allocate between uses.In other words, a democratic government is the only one in which those who vote for a tax can escape the obligation to pay it.
Alexis de Tocqueville -
Agree with DaveO, but I believe you must elect to treat the debt as not secured by the home by attaching a statement to the the tax return. Check in TTB I don't have it with me but I knw it's discuss and I have done this with business interest.Comment
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Correction to original post
The new building is not on the same lot. It is on an adjacent lot. So the mortgage is only backed by the first property. I felt comfortable taking all interest as first home interest where the two homes were right next door to each other and both used by family as a first home. If the new home is converted to rental then I think that if my client refiances the second property for the amount that is left on the debt applicable to buying and fixing up that house and pays down the debt on the first property by this amount that he can deduct all interst. If he does not do this, then he loses the interest on the new debt as it is no longer home mortgage interst and it can't be treated as rental interest as a tracing election was not made on the tax return in the year the debt was created. Anyone disagree?Comment
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I am curious as to how an owner can use two different homes as his primary residence. Does he sleep in them on alternate nights?Comment
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Is there not a bigger issue?
First house mortgage interest limited to original, plus improvements and $100,000. Obviously there are some more rules. Do you avoid the rule for deductable interest rules because of the "compound"-maybe, do you avoid the rules when changing to a rental-maybe?, but I have never been there.Comment
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I don't think there's such a thing as a "tracing election." Tracing happens, like it or not, and in this case, the tracing traces the interest to what was built with the proceeds of the debt, which is, now, rental property. Security is irrelevant and the interest expense goes on Schedule E. Best I can figger...Comment
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I respectfully disagree for interest secured by a home. See The Tax Book page 4-11. A taxpayer can elect to treat debt secured by a home as not secured by a home [Reg. 1.163-10T(o)(5)].Comment
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