Mortgage Interest-Acquisition Debt

[equinecpa]

My client has a main home and a few years ago bought a vacation home using a home equity loan secured by their main home. I've been restricting the interest claimed on that to the first $100000 of home equity loan.

They are refinancing their main home now and will roll the home equity loan into that-will all the new loan interest be deductible now? I'm thinking yes since the Home Equity Loan was used to purchase the 2nd home so by tracing the flow of funds the new loan is all home acquisition debt (except for perhaps any fees rolled into the loan). Am I right on this?

Carolyn

[mactoolsix]

Yes, BUT . . .

You need to allocate the funds as they were used.

Primary residence original acquisition debt was 500,000 - paid down to 400,000
Vacation home original acquisition debt 100,000 - paid down to 80,000

Refinancing the above two loans will give you:
Primary residence acquisition debt of 400,000
Equity debt of 80,000.

You can now add an additional 20,000 of equity loan balance (to purchase a car or other item), but since the equity loan is not for the purchase or improvement of the primary residence, it cannot be characterized as acquisition debt. The best way to purchase a second home is to secure the original acquisition debt to the second home. What happens if they now sell the primary residence? The loan interest deduction vanishes!

[veritas]

I don't believe the new mortgage

will change the character of the existing loans for tax purposes.

You will still have the aquisition debt for the main home and equity debt for the vacation home. Principal payments would be applied first to the equity debt.

[appelman]

I agree with veritas

will change the character of the existing loans for tax purposes.

You will still have the aquisition debt for the main home and equity debt for the vacation home. Principal payments would be applied first to the equity debt.

I don't think tracing rules apply to Schedule A. Doesn't Sch A acquisition debt have to be secured by the particular property for which the proceeds are used?

[mactoolsix]

I don't think tracing rules apply to Schedule A. Doesn't Sch A acquisition debt have to be secured by the particular property for which the proceeds are used?

You are correct - Tracing rules do not apply to Sch A acquisition or equity debt. But that does not change the fact that the character of the acquisition debt and equity debt remains the same because of the original use of the funds.

Seems we are all in agreement here . . . acquisition debt must be secured by the particular property for which the proceeds were used.

[equinecpa]

One more question on this...if the Home Equity Loan of 150K (which was used to purchase vacation home) is paid off by taking out a mortgage on the vacation home, would all of the vacation home mortgage interest now be deductible?

[veritas]

it would not

One more question on this...if the Home Equity Loan of 150K (which was used to purchase vacation home) is paid off by taking out a mortgage on the vacation home, would all of the vacation home mortgage interest now be deductible?

Be considered aquisition debt. It would qualify for equity debt up to 100k.