Mortgage interest deduction

[Bird Legs]

Situation: Father dies in 2001. A family trust is established with assets from the estate.
Daughter, in 2004, borrows $100,000., @5% interest, from the family trust for a down
payment on a new home. The trust takes a lien on the daughters previous home, which
she turned into a rent house when new home was purchased.
in 2005, daughter pays $5000. in interest to the trust on the loan.
Question: Is this $5,000. deductible and if so where? Sched. E rental expense?
Sched. A itemized deduction as a home mortgage interest?
Thank you all for you help.

[jainen]

It is not deductible

It is not deductible as home mortgage interest because the loan is not secured by the home.

It is not deductible as a rental expense because the loan proceeds were not used in the rental activity.

Why not ask the trust to put a lien on the primary residence as additional collateral?

[Bird Legs]

Lien

Jainen, could a lien be placed on the residence retroactively, dated in 2005?

[jainen]

back-dating documents

>>could a lien be placed on the residence retroactively<<

No. A lien doesn't count for third parties (like the IRS), until it is recorded at the county courthouse. Down there, they aren't very cooperative about back-dating documents.

[Bird Legs]

Just remembered

something. Probably will not help, however, in 2006 the daughter sold the rent house
and when this occurred she said the lien was transferred to the residence.
Will, or can, this make a difference for 2005? Probably not, but just fishing.
Thanks, Jainen, your help is appreciated.

[jainen]

Happens to my clients all the time

I see -- you just "remembered" the rental was sold and the subject lien is actually on the home after all? Well, I can understand how you might forget some of the small details like that. Happens to my clients all the time.

Unfortunately it doesn't change my previous answer. When you do the 2006 return, don't forget to remember that the lien was transferred WHEN the rental was sold. You have to prorate the interest deduction from then.

[Roland Slugg]

May not be &quot;Acquisition Indebtedness&quot;

FWIW I agree with Jainen's first post above in reply to the original question. It's also possible that the $100k loan may not qualify as acquisition Indebtedness as that term is defined by the Code or Regs. As I recall there is a time limit of something like two years for post-acquisition debt to be considered acquisition Indebtedness. If it's not, then it must be treated as a home equity loan. Fortunately, the $100k loan does not exceed the limit on the deductibility of interest on a HE loan. However, it's right at the limit, so it might be prudent to advise your client that if the $100k must, in fact, be treated as a HE loan, than she won't be able to deduct the interest an any additional loans she may add to the property.

[Zee]

Time for another dumb question

Here's a question that was asked on another board. TP obtains a $100,000 home equity loan on his residence. He uses the proceeds as the down payment on another residence, and converts the original residence to a rental. How is the interest expense reported? Would your answer be any different if the TP was renting the original residence on a temporary basis while trying to sell?

[jainen]

same question

>>another dumb question<<

I think it's the same question. Anyway, same answer. Home mortgage interest refers to primary or secondary home, not former home.

Oh, all right. I'd let it go as "second home" for a reasonable time if he is really trying to sell.

[Bird Legs]

Happens to my Clients all the time

Jainen, please forgive my memory. My age has overtaken my mind and occasionally,
my memory takes a rest.

[jainen]

primary objection

>>age has overtaken my mind<<

I know from personal experience that it happens. But I always feel a disconnect when, after I lay out the tax consequences, the client suddenly remembers that he explained it wrong--the true facts are exactly the opposite of my primary objection.