Deducting Mortgage Interest

[Kram BergGold]

This has come up twice this week. Taxpayer wants to borrow money using stocks in a brokerage account as collateral to buy a principal residence. We know this is not deductible. Then they want to take out a real mortgage to pay off the brokerage loan. Is that mortgage considered debt to buy or improve a home, so the interest is deductible?

[TaxGuyBill]

If it is all done in a very short time frame, I would say yes.

However, that stirs up my curiosity to ask: If he is going to take out a 'real' mortgage anyways, why doesn't he just start with that?

[JohnH]

It's my understanding that only money borrowed within 90 days of purchasing the home can qualify as "Home Acquisition Debt", limited to the acquisition cost of the residence, under both the old and the new law. In the past, the first $100K of the amount borrowed to repay the brokerage loan could be used as HELOC debt even if it didn't qualify as home acquisition debt, but that option is now out the window.

So if your client waits more than 90 days to borrow the money to pay off the brokerage loan with a mortgage secured by the residence, he is forever out of luck on the mortgage interest deduction on that property. And even if he borrows the money within the 90 day period, he cannot count the loan costs (origination fee, attorney fees, etc) as a part of the home acquisition debt. So he must do an allocation of the deductible and small amount of non-deductible interest as long as he has the loan. If I'm wrong on any of this hopefully someone will jump in and correct me.

One example of a situation in which someone might buy the home with a non-mortgage loan would be if there isn't sufficient time to process a mortgage loan prior to closing. For example, if they committed to a quick closing as a part of the offer, if they decided to strengthen their offer by omitting a loan contingency, or if there's a loan involved but an unanticipated delay in loan approval is encountered.

[Kram BergGold]

Thanks John H

I never knew about this 90 day rule. Thanks for teaching me about it.

[JohnH]

Glad to help out. I didn't know the specifics until I found myself in a similar situation to your client last year when I wanted to purchase a home with no loan contingency in the offer. That caused me to look very carefully at what I needed to do to preserve the interest deduction on the eventual mortgage. (And this was before the late-2017 changes were known). Fortunately it all worked out.

[New York Enrolled Agent]

Glad to help out. I didn't know the specifics until I found myself in a similar situation to your client last year when I wanted to purchase a home with no loan contingency in the offer. That caused me to look very carefully at what I needed to do to preserve the interest deduction on the eventual mortgage. (And this was before the late-2017 changes were known). Fortunately it all worked out.

John H - do you have a cite for this 90-day rule? Unfortunately we can't use JohnH as a source of authority.

[Gene V]

Acquisition Loan

This is a interesting example from Pub 936 page 9--Acquisition Loan

Example 1. You bought your main home on June 3 for $175,000. You paid for the home with cash you got from the sale of your old home. On July 15, you took out a mortgage of $150,000 secured by your main home. You used the $150,000 to invest in stocks. You can treat the mortgage as taken out to buy your home be-cause you bought the home within 90 days be-fore you took out the mortgage. The entire mort-gage qualifies as home acquisition debt because it wasn't more than the home's cost.

https://www.irs.gov/pub/irs-pdf/p936.pdf

[TaxGuyBill]

Right above that example in Publication 936, it says:

Mortgage treated as used to buy, build, or improve home.

A mortgage secured by a qualified home may be treated as home acquisition debt, even if you don't actually use the proceeds to buy, build, or substantially improve the home. This applies in the following situations.

You buy your home within 90 days before or after the date you take out the mortgage. The home acquisition debt is limited to the home's cost, plus the cost of any substantial improvements within the limit described below in (2) or (3). (See Example 1 later.)

You build or improve your home and take out the mortgage before the work is completed. The home acquisition debt is limited to the amount of the expenses incurred within 24 months before the date of the mortgage.

You build or improve your home and take out the mortgage within 90 days after the work is completed. The home acquisition debt is limited to the amount of the expenses incurred within the period beginning 24 months before the work is completed and ending on the date of the mortgage. (See Example 2 later.)

https://www.irs.gov/publications/p936#en_US_2017_publink1000229996

I think it comes from IRS Notice 88-74. I can't find an IRS link for that Notice, but here is a third-party link that has that Notice:

http://www.sjsu.edu/people/annette.nellen/website/225K%20Reading/N88-74.pdf

[New York Enrolled Agent]

TGB - a good place where you can find those notices is www.legalbitstream.com

Free to use

[TaxGuyBill]

Thanks. Yeah, I use that for research, but if I remember correctly, you can't 'link' things to it. The URL 'link' is a temporary one or something, so giving a link won't get you to the specific thing (if I remember correctly).

[JohnH]

John H - do you have a cite for this 90-day rule? Unfortunately we can't use JohnH as a source of authority.

Nah, no cite. I did my research last year when I was in a similar situation, but I didn't keep any of it. There was enough similarity between the original question and my circumstances that I felt comfortable just responding from memory. I'm pretty sure I relied on the pubs, as has been mentioned by Gene and Bill. That was good enough for me in my situation, and I acted on it.

But to the main question - by all means, don't ever use me as a source of authority. Trust, but verify.