10-T Election & Loan Repayment Ordering Rules

[Gretel]

Do the ordering rules also apply to repayment of mortgage for a personal residence after a 10-T Election (treat part of qualified mortgage interest as non-qualified)? Interest calculation are quite different if ordering rules have to be followed or if the % of non-residence related interest can be calculated using the same % as the original debt allocated to investment/business.

[Rapid Robert]

Do the ordering rules also apply to repayment of mortgage for a personal residence after a 10-T Election (treat part of qualified mortgage interest as non-qualified)?

I think the stumbling block here might be the position that many tax preparers take, which is that when you make a 10-T election to treat "the debt" as non-qualified, it is all or nothing, and you can't just treat part of mortgage as non-qualified. I don't agree with this, since "the debt" is not defined. Is it simply anything the bank assigns a (sub-)account number to? Every time I write a check against my HELOC, I consider it a separate "debt" because it has a unique origin date, principal amount, and term.

Even with my interpretation, no. the ordering rules would not apply, as we are talking about interest tracing, not payback of principal related to partly-deductible/partly-non-deductible interest.

[Gretel]

I think the stumbling block here might be the position that many tax preparers take, which is that when you make a 10-T election to treat "the debt" as non-qualified, it is all or nothing, and you can't just treat part of mortgage as non-qualified. I don't agree with this, since "the debt" is not defined. Is it simply anything the bank assigns a (sub-)account number to? Every time I write a check against my HELOC, I consider it a separate "debt" because it has a unique origin date, principal amount, and term.

Even with my interpretation, no. the ordering rules would not apply, as we are talking about interest tracing, not payback of principal related to partly-deductible/partly-non-deductible interest.

Thanks Rapid Robert - however, now I am thoroughly confused. This is a refi on the home split 3 different ways - 1. non-deductible used to pay off credit card debt, 2. home interest and 3. funds used for business building on property.

Isn't interest tracing linked to principle pay back? The monthly mortgage payment is interest and principle. Am I dense?

[Rapid Robert]

This is a refi on the home split 3 different ways - 1. non-deductible used to pay off credit card debt, 2. home interest and 3. funds used for business building on property.

Isn't interest tracing linked to principle pay back? The monthly mortgage payment is interest and principle. Am I dense?

Yes, for most borrowers the monthly mortgage payment is interest and principal. Not sure what that has to do with your question.

Yes, under the ordering rules for qualified home mortgages, principal payments go first to pay down home mortgage debt that is neither acquisition nor equity debt (using the tax law definition of "acquisition" and "equity"), then equity debt, then acquisition debt.

Under the 10-T election, as most interpret it, if you elect to treat the entire debt as not qualified home mortgage debt, then you have no "home interest" at all, because you elected not to. I am not aware of any "ordering rules" that apply in this situation.

All you have is the money actually spent on the business, and if there is any additional principal after that, the interest on that amount is non-deductible. If your non-qualified-mortgage loan is, for example, 30% used in the business and 70% personal, then under interest tracing you can deduct 30% of the interest against the business income, and you can't deduct the other 70% anywhere.

I think this is why it is not common for people to make the 10-T election.

[TaxGuyBill]

By "ordering rules", I think Gretel is referring to how the payments of principal are applied.

To put that in an example: If the home acquisition debt is $70,000 and the business debt is $30,000, and you make a $10,000 payment for principal, how is it applied? Does the $10,000 come off the $70,000? Does it come off of the $30,000? Or is it prorated 70%/30%?

I am not positive of the answer, but I would THINK the same "ordering rules" would apply as any other traced debt, which would NOT be prorated (I don't remember offhand what the order is, or even which Reg that is in; I would need to look it up). Again, that is just off the top of my head, so I could be wrong.

[Gretel]

Thanks guys. Yes, TaxGuyBill translated my question nicely into plain words. There is a good example in TTB Deluxe pg. 4-15 (Reg. 1.163-8T). RapidRobert, I always only used part of the principle from a home mortgage for the 10-T election and stated that amount in the statement attached to the tax return. I wasn't even aware that there are interpretations that say all or nothing. What do you base your opinion on that the 10-T election does not necessarily apply to 100% of the home mortgage?

Now, there actually is a follow up question. The part of the home mortgage used for business pertains to home office expenses after TP started his own business. I am actually not sure any longer if this kind of business interest isn't still considered home mortgage interest even though it is allocated to Schedule C. OIH consists of two components - 1. office space in home, 2. storage in detached garage.

[Rapid Robert]

By "ordering rules", I think Gretel is referring to how the payments of principal are applied.

LIke the ones I stated in post #4? "Yes, under the ordering rules for qualified home mortgages, principal payments go first to pay down home mortgage debt that is neither acquisition nor equity debt (using the tax law definition of "acquisition" and "equity"), then equity debt, then acquisition debt."

Per Pub 535, there are also ordering rules for paying back business loan principal:
.

Loan repayment.

When you repay any part of a loan allocated to more than one use, treat it as being repaid in the following order.

• Personal use.
• Investments and passive activities (other than those included in (3)).
• Passive activities in connection with a rental real estate activity in which you actively participate.
• Former passive activities.
• Trade or business use and expenses for certain low-income housing projects.

As for the 10-T election, TheTaxBook clearly states it is all or nothing, see page 4-11. "The election must apply to the entire indebtedness and is made by deducting the interest on the applicable Form or Schedule." However, not everyone agrees, as I stated previously in this thread. In fact, here is a thread from this forum from 2012 that Gretel participated in, where different opinions were expressed.

https://forum.thetaxbook.com/forum/discussion-forums/main-forum-tax-discussion/21127-home-equity-loan-for-rental-property

"Also, it must be the whole loan, not a part of it."

Obviously, it is more desirable for the election to apply to just as much of the loan as you want, and that's the way I like it. But I am not a tax court.

[Rapid Robert]

See also the following CC memo. They appear to draw a distinction between when the election is made (entire debt only) or when the election is not made. Maybe someone here can break it down more concisely.


Office of Chief Counsel
Internal Revenue Service
memorandum
Number: 201201017
Release Date: 1/6/2012

The regulations under section 1.163-10T(o) and Publication 936 both state that
taxpayers may make an election to treat a debt that is secured by a qualified residence
as not secured by a qualified residence. 3 The election must apply to the entire
indebtedness, and the election is made by reporting the interest on the return as
business interest or other deductible interest rather than qualified residence interest.
Late elections have been permitted under section 301.9100 of the regulations. A
purpose of this election is to permit a debt that is allocable to trade or business
expenses, and thus deductible without regard to the section 163{h) deduction, to not
"use up" the limitation, thereby causing otherwise deductible debts to fail to qualify
under the limitation. In addition, the election permits interest on the debt to qualify as an
"above the line" deduction (i.e., deductible under section 62 as a deduction allowable in
determining adjusted gross income) to the extent the debt is allocable to a trade or
business or rental expenditure.

"Question 2. If a taxpayer may use the exact method, must the taxpayer elect
under section 1.163-10T(o)(5) to treat the debt as not secured by the qualified
residence in order to allocate the interest on the part of the debt that exceeds the
qualified residence interest limitations according to the use of the proceeds as provided
in section 1.163-BT?

Conclusion: A taxpayer using the exact method, or any other reasonable
method, is not required to make the election under section 1.163-10T(o)(5) in order to
allocate the interest on the part of the debt that exceeds the qualified residence interest
limitations under section 1.163-ST. The election under section 1.163-10T{o){5) applies
only to the whole amount of a debt and not to part. When the election is made under
section 1.163-10T(o){5), the entire debt is treated as not secured by the residence;
when the election is not made, only the portion of the debt that exceeds the limitation is
traced according to the use of the debt proceeds.

Question 3. If a taxpayer uses the simplified method, may the taxpayer allocate
excess interest under the interest tracing rules of section 1.163-ST without making an
election under section 1.163-1 O{ o )(5) to treat the debt as not secured by a qualified
residence?

Conclusion. A taxpayer using the simplified method may allocate excess interest
under the interest tracing rules of section 1.163-ST, as described in the instruction to
line 13 of the worksheet in Publication 936, without making an election under section
1.163-10T(o){5). The method provided for in Publication 936 is another reasonable
method allowed by the legislative history."

[Gretel]

See also the following CC memo. They appear to draw a distinction between when the election is made (entire debt only) or when the election is not made. Maybe someone here can break it down more concisely.


Office of Chief Counsel
Internal Revenue Service
memorandum
Number: 201201017
Release Date: 1/6/2012

The regulations under section 1.163-10T(o) and Publication 936 both state that
taxpayers may make an election to treat a debt that is secured by a qualified residence
as not secured by a qualified residence. 3 The election must apply to the entire
indebtedness, and the election is made by reporting the interest on the return as
business interest or other deductible interest rather than qualified residence interest.
Late elections have been permitted under section 301.9100 of the regulations. A
purpose of this election is to permit a debt that is allocable to trade or business
expenses, and thus deductible without regard to the section 163{h) deduction, to not
"use up" the limitation, thereby causing otherwise deductible debts to fail to qualify
under the limitation. In addition, the election permits interest on the debt to qualify as an
"above the line" deduction (i.e., deductible under section 62 as a deduction allowable in
determining adjusted gross income) to the extent the debt is allocable to a trade or
business or rental expenditure.

"Question 2. If a taxpayer may use the exact method, must the taxpayer elect
under section 1.163-10T(o)(5) to treat the debt as not secured by the qualified
residence in order to allocate the interest on the part of the debt that exceeds the
qualified residence interest limitations according to the use of the proceeds as provided
in section 1.163-BT?

Conclusion: A taxpayer using the exact method, or any other reasonable
method, is not required to make the election under section 1.163-10T(o)(5) in order to
allocate the interest on the part of the debt that exceeds the qualified residence interest
limitations under section 1.163-ST. The election under section 1.163-10T{o){5) applies
only to the whole amount of a debt and not to part. When the election is made under
section 1.163-10T(o){5), the entire debt is treated as not secured by the residence;
when the election is not made, only the portion of the debt that exceeds the limitation is
traced according to the use of the debt proceeds.

Question 3. If a taxpayer uses the simplified method, may the taxpayer allocate
excess interest under the interest tracing rules of section 1.163-ST without making an
election under section 1.163-1 O{ o )(5) to treat the debt as not secured by a qualified
residence?

Conclusion. A taxpayer using the simplified method may allocate excess interest
under the interest tracing rules of section 1.163-ST, as described in the instruction to
line 13 of the worksheet in Publication 936, without making an election under section
1.163-10T(o){5). The method provided for in Publication 936 is another reasonable
method allowed by the legislative history."

This is helpful and makes things clearer. This just addresses home mortgage interest deduction limitations and not other scenarios when not all of a home mortgage qualifies as home mortgage deduction and one would think that the same rules would apply.