Drop in home vaules affect equity interest deduction?

[GTS1101]

I recently read an article from a highly respected tax professional that I am not sure I agree with. I wanted to pick some of your brains to see what you thought. I looked at IRS code 163 and also at Pub 936.

The article states that "If the drop in your home value has eaten up the equity in your house, you are not allowed any deduction for interest on home equity debt." The article goes on to say that you are still allowed to deduct the interest on acquisition indebtedness and it has nothing to do with the level of your equity in your home.

I was going to post an article on my website regarding this limitation to inform my clients when what I read in Pub 936 did not match with what this tax professional wrote in his article. Pub 936 under Home Equity Debt states that home equity debt is limited to the smaller of 100,000 or The total of each home's (FMV) reduced(but not below zero) by the amount of its home acquisition debt and grandfathered debt. Determine the FMV and the outstanding home acquisition and grandfathered debt for each home on the date that the last debt was secured by the home.

As I understand Pub 936 it is the FMV from the time your last debt was secured. So if you bought a home in 2004 for 500,000 and the value increased to 600,000 in 2006 and you took out an equity line of credit for 100,000 that interest is going to be fully deductible regardless of the value in 2009 because it is based on the FMV from the time the last debt was secured which was 2006 when the value was 600,000.

But as I went to the IRS Code section 163 under Home Equity Indebtedness it says:

(C) Home equity indebtedness
(i) In general The term “home equity indebtedness” means any indebtedness (other than acquisition indebtedness) secured by a qualified residence to the extent the aggregate amount of such indebtedness does not exceed—
(I) the fair market value of such qualified residence, reduced by
(II) the amount of acquisition indebtedness with respect to such residence.
(ii) Limitation The aggregate amount treated as home equity indebtedness for any period shall not exceed $100,000 ($50,000 in the case of a separate return by a married individual).

In IRS Code section 163 above it does not say how to determine the FMV. It only says FMV. Is that the FMV when the last debt was secured or is that the current FMV for that given year? It seems like the author of the article I read is basing his conclusion on IRS Code section 163. But Pub 936 seems to say something different. So if you follow Pub 936 is the IRS going to deny the deduction because IRS Code supersedes the Publications. Maybe there is a regulation that helps to clarify. Would appreciate any wisdom or light you can shed on this issue as it will be very important this upcoming tax season.

Thanks!

GTS1101

[erchess]

Two Points

My first point is that The IRS Pubs are not authorities and the service can and will tell you that a given statement in a Pub is not true and penalize you and your client for relying on it. It is unusual for this to happen because in most cases the Pubs say exactly what the IRS correctly believes the law to be. It is also not unheard of for a tax professional considering a question of law on a tax return to read the relevant pub and research no further

My second point is that in my opinion TTB 1040 Edition p 4-11 bottom left indicates that it is FMV as of when the newest debt was taken out. That seems reasonable to me because we have a reasonable estimate that was done by the lender and the only way to get a better figure would be to require the taxpayer to pay for an estimate every year at tax time which would put more burden on the taxpayers than the question is worth.

[Corduroy Frog]

Disagree with article

...if it implies a lower equity takes priority over the equity supporting the debt at the time the debt was made.

I rarely make such a statement as the one to follow: "If the code/regulations imply a lower equity is to be used than that which existed at the point of indebtedness, this should be resolved with a congressional Technical Correction if need be."

I'm aware this is a "God-Like" position but clearly this was not intended in the legislation.

[S T]

Help Bees???

I think I would also agree - the statement that you are referring to "hopefully can not be correct or should not be correct" If it is correct, ????
It seems it would be a very large "detriment and inequity to the taxpayer" if we had to look to the FMV at current standards (decrease in value of real estate) for a loan that was placed in effect during a "rising market" (increase in real estate values on which the loan was predicated through appraisal"

I have limited mortgage interest deductions already several of my tax clients to the acquistion and $100K rules due to refinancing and that was a huge impact affecting their tax deductions - but this would be worse.

Maybe Bees can jump in here and give us some guidance and what to expect for 2009 and moving forward?

Sandy

[newbie]

This could be nasty. Home equity line of credit could be treated different too. The value was there when the line was taken out and continues as value drops but you're paying off and re-borrowing.

[Bees Knees]

Regulation Section 1.163-10T(e)(2) says:

Determination of applicable debt limit. For each secured debt, the applicable debt limit for the taxable year is equal to
(i) The lesser of—
(A) The fair market value of the qualified residence as of the date the debt is first secured, and
(B) The adjusted purchase price of the qualified residence as of the end of the taxable year,
(ii) Reduced by the average balance of each debt previously secured by the qualified residence.

The problem is, Regulation Section 1.163-10T has not been updated by IRS since the passage of Public Law 100-203 which is the Omnibus Budget Reconciliation Act of 1987. That is the law that first amended IRC Section 163(h)(3) and introduced the $1 million acquisition debt limit and $100,000 home equity debt limit. Thus, the regulations have not been updated since 1987 to define FMV for purposes of determining the home equity debt limit.

However, I think IRS Pub 936 is still correct. They would not have put that language in the Pub if there was some ruling that changed the meaning of FMV. The 1987 law merely changed the dollar limits on qualified home mortgage interest debt, creating a new category for acquisition debt and home equity debt. It did not change how to determine fair market value for purposes of placing a limit on qualified home debt. The same FMV rule existed in the code prior to 1987 as well as after the law change, so there is no reason to think there is a new definition of FMV.

[GTS1101]

Thanks!

Thanks Bees! and everyone for their input. I don't know about all of you but this is what I love about the tax law. You might think I am nuts but I love it because it keeps the job interesting. I am passionate about what I do and I look forward to each and every tax season. Sure I get stressed and I get tired during tax season but I love helping people, meeting with people, helping them get all the credits and deductions they are entitled to within the law, and helping them pay the least amount of tax. I love to research too. And when things are not always clear for me it keeps the job interesting and keeps me using my brain. I hope they never go to a flat tax. I don't ever want to retire from doing taxes. As long as I can use a computer I want to always do taxes either full time or part time as I get older. And now that I will have my EA in about 60 days I can't wait to start helping people solve their IRS problems by standing up and defending their rights.

Thank You!

GTS1101