Interest Expense

First the bad news: Generally, personal interest expense is not tax deductible. 🙁
But there are a number of exceptions to this rule, and for each of the exceptions there are additional limitations or “exceptions to the exception.”

This page discusses many of these exceptions.

  • Principal Residence Secured Mortgage Interest Expense (for property acquired before 2018)
    • ○ up to $1MM of secured mortgage debt incurred for the original acquisition or construction plus any secured mortgage debt to substantially improve the property.  Including any secured mortgage debt resulting from a refinancing, but only to the extent that the loan balance does not exceed the amount of the refinanced indebtedness.  Debt qualifying as acquisition debt may be obtained up to 90 days before or after the purchase. See IRS Publication 936 and IRS Notice 88-74.
    • ○ up to $100K of HELOC debt. See Rev. Rul. 2010-25

  • One additional residence – Vacation Home Secured Mortgage Interest Expense (for property acquired before 2018)
    • ○ up to $1MM of secured mortgage debt incurred for the original acquisition or construction plus secured mortgage debt to substantially improve the property. Including any secured mortgage debt resulting from a refinancing, but only to the extent that the loan balance does not exceed the amount of the refinanced indebtedness.
      • ◙ not to exceed $1MM combine total for both the Principal Residence and the Vacation Home
    • ○ up to $100K of HELOC debt
      • ◙ not to exceed $100K combine total for both the Principal Residence and the Vacation Home
    • ○ not to exceed an overall $1.1MM combine total for both the Principal Residence and the Vacation Home

  • For property acquired before 2018 when the total of debt on both residences exceeds the $1.1MM overall limitation, then a fairly complicated allocation between deductible and nondeductible interest needs to be sent to the IRS each year

  • If there is one acquisition debt on one home acquired before 2018, then a full $1.1MM may be deductible pursuant to CCA200940030. and Rev. Rul. 2010-25.

  • Starting for acquisitions after 2017, interest on only $750,000 of debt is allowable.

  • Starting with 2018, interest on HELOC debt is generally not deductible.

  • The above covers your main home and your second home (you may only have one second home at a time).  A home includes a house, duplex, condominium, cooperative, manufactured home, mobile home, house trailer, boat, or similar property that has sleeping, cooking, and toilet facilities.

  • The above limitations generally apply to each individual co-owner of the residence. If two such individual co-owners subsequently get married, then the limitation applies to the couple whether they choose to file married jointing or married separately.  Example:  two individual co-owners may deduct up to $2.2MM, but once they are married, only up to $1.1MM would be deductible as homeowner interest.  See Voss v. Comr. 2015   Also see TaxProfBlog

  • With regards to the taxpayer’s original acquisition loan for the principal residence, the mortgage points, loan origination fees or loan discount etc. (points) – they are generally currently deductible if the taxpayer chooses to do so. It generally makes no difference whether the buyer or the seller actually pays the points. But points paid during a refinance of the principal residence loan are not currently deductible, rather they are amortized over the life of the replacement loan or until that loan is paid off or under certain conditions, when it is refinanced again.  See the list of 9 conditions/requirements here: IRS Topic 504.

  • A taxpayer might choose to not deduct points currently if he is not benefiting from itemizing deductions (such as a first time homeowner’s purchase late on the year).  Then upon refinance in a future year the unamortized points may be fully deductible.

  • Delinquent past due interest that is capitalized as part of a loan modification with the same lender likewise is amortized over the life of the modified loan, or until that loan is paid off.  Copeland v Commissioner T.C. Memo. 2014-226  Bank of America was sued in 2014 for failing to show this amortized interest on IRS Form 1098. Smith et al. v Bank of America  also see Forbes Jan 6, 2015.

  • An irrevocable election (10-T election) may be filed to treat the secured debt as unsecured debt pursuant to Reg. §1.163-10T(o)(5) (for example to allow the interest expense to be considered investment interest for long-term investments or trader status interest for active daytraders).

  • Equitable ownership may result in the “Principal Residence Secured Mortgage Interest Expense” to be deducted by an individual who is not named on the title deed and/or not directly liable on the mortgage note.  see Edosada, T.C. Summary 2012-17 and Uslu, T.C. Memo. 1997-551   Also see old Forbes discussion (but note that the 2012 Sophy ruling was since reversed in 2015).

  • Reverse Mortgage interest generally accrues on the reverse mortgage proceeds but that accrued interest is not deductible until it is paid.

  • Can taxpayers deduct mortgage interest on a residence when the property title and mortgage are held in a another person’s name?
    Uslu v Commissioner, T.C. Memo. 1997-551: Where the taxpayers are equitable and beneficial owners of the property, enjoying exclusively the burden and benefit of the property, payments of interest are deductible. (See Federal Tax Regulation 1.163-1(b))

  • Equitable Owner Equals Deduction See Ndile George Njenge and Ekinde Sone Nzelle Rachel v. Commissioner, TC Summary Opinion 2008-84

 

 

  • Trade or Business Interest Expense
  • Employee Business Interest Expense
    • ○ generally limited to the 2% itemized deduction limitation
    • ○ Starting with 2018, Employee Business Interest Expense is generally not deductible.
    • ○ but generally no limitation for actors, performing artists, and some handicapped, military & fee-based gov’t officials because their deduction is taken “above the line”

  • Motor Vehicle Loan Interest Expense
  • Investment Interest Expense & Margin loan interest
    • ○ tracing rules apply to prove that the borrowing was actually used (generally within 15 days or 30 days of receipt, see IRS Notice 89-35) to carry the investment
    • ○ generally limited to investment income, with the excess carried forward to future years
    • ○ generally a written Reg. §1.266-1(c) election may be made annually to capitalize interest and/or property taxes and/or certain other carrying costs and necessary expenditures rather than deduct them. (in the case of real estate – for unimproved real estate or real estate that currently is being developed) 

  • Student Loan Interest Expense
    • ○ Up to $2,500 is deductible, but generally subject to those former students who have no more than $80,000 income ($160K if married filing jointly)
    • ○ If parents pay the interest on behalf of the student it is treated as a payment the student, who in turn pays the interest Reg. §1.221.1(b)(4)

  • Rental Real Estate Interest Expense
    • ○ tracing rules apply to prove that the borrowing was actually used (generally within 15 days or 30 days of receipt, see IRS Notice 89-35) to acquire or improve the property
    • ○ generally subject to a number of limitations as discussed here and discussed here


Some deductible interest is an itemized deduction, so individuals who use the standard deduction in lieu of itemizing, will get little or no value form the interest deduction.

But Trade or Business and Rental Real Estate and Student Loan deductible interest is generally taken “above the line” so the standard deduction and 2% limitations to not apply.

IRS Publication 936

 

 

Partnerships issuing Schedule K-1 to partners
Interest income from working capital is sourced to the state where partnership’s operations occur. Interest income from investments that were made by the partnership is intangible and therefore it is sourced to state of residence (or domicile) of each individual partner.