interest on additional lot

[Kram BergGold]

My client purchased a second home 2 years ago. Now she wants to buy the vacant lot next door to it. Due to zoning laws, if she buys, she does not want to retitle the two deeds into one. My feeling is, if the house is under one deed and the land next door is under another deed that any interest she pays on the mortgage to buy the land will not be deductible as second home interest. It will have to be investment interest and as she has very little investment income we will either have to elect not to deduct it or just let it build up as investment intererst carryforward, agree or diasagree?

[Bruce Barker]

lots

If the lots are abutting and total under 10 acres I'd call it all mortgage interest.

[Bees Knees]

The rules that allow you to combine properties into one for tax purposes apply to the home sale exclusion rules under Section 121. If the lot is adjacent to her main home, the lot can be sold within 2 years of the sale of the main home and the gain can be excluded.

The problem is, tax law is not always consistent. Number one, this house is not her main home, so Section 121 does not apply. Number two, we are talking about deductible mortgage interest under Section 163, not the home sale exclusion rules under Section 121.

Just because a set of rules applies to Section 121, that does not mean you can apply the same principal to Section 163.

Therefore, if the lot is purchased for investment purposes and is not considered the same property as her 2nd home, the mortgage interest rules of Section 163 cannot apply.

It is also questionable whether this lot would qualify as investment interest. If it is adjacent to her 2nd home, and the 2nd home is used for personal purposes, chances are the lot will also be used somewhat for personal purposes. She will probably walk on it, or the kids will play on it, or something that will disqualify it as investment property. Thus the interest would be considered personal interest rather than investment interest.

[Kram BergGold]

Clarification

Bees,
My client's primary residence is on lot A. They bought the lot next door, lot B, and tore down the house. Each lot has a separate deed. If they had rewritten the deeds to make one deed I would deduct all interest applicable to the purchase of the lot and the tearing down of the building as aquisition debt of house A, as they used a line of credit from house A to finance this endeavor. Would this approach be ok if the two properties have their own are deeds. From your post I am thinking this is ok.
As you reminded me, if they sold both within two years they would get Section 121 on both.

[ChEAr$]

Maybe I'm confused, but....

Bees,
My client's primary residence is on lot A. They bought the lot next door, lot B, and tore down the house. Each lot has a separate deed. If they had rewritten the deeds to make one deed I would deduct all interest applicable to the purchase of the lot and the tearing down of the building as aquisition debt of house A, as they used a line of credit from house A to finance this endeavor. Would this approach be ok if the two properties have their own are deeds. From your post I am thinking this is ok.
As you reminded me, if they sold both within two years they would get Section 121 on both.

Your original post said: "My client purchased a second home 2 years ago. Now she wants to buy the vacant lot next door to it."

By "second home", I thoughtyou meant a second residence, but here lately you say
that the primary residence is on lot A. So I'll go with your second explanation., by which
I take it that the primary residence is on lot A and there IS no secondary residence; right?

So if the lot next door is purchased, even if on a separate deed, and that lot is
integrated with the primary residence's lot, then both are underlying the primary residence
and mortgage interest is deductible.

[Kram BergGold]

Harlan and Bees

I had a senior moment and took two client scenarios I am dealing with and combined them. My original post was correct for this scenario. Client owns residence, house A (2/3 of which is rental) and second home, house B. She wants to purchase the lot next door to B but does not want to retitle.
If she takes out a mortgage on house B or the lot I would be ok taking it as investment interest. The question is could it be called aquisition debt. Bees seems to say yes if it were a primary residence, and I agree with his logic using Section 121 as a way to argue. But where it is a second home without that 121 arguement maybe it would be too mcuh of a stretch.
If she takes out a home equity mortgage on house A we have the problem that 2/3 of house A is not a residence, it is rental, so the best I could do is elect out of home mortgage rules on 2/3 and trace to the investment and then claim 1/3 as home equity debt.
How does this sound?