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interest allocation of mixed use mortgage

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August 27, 2023
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I am having a tough time with IRS Pub 936, their definitions and their worksheets

I did a refi of my primary home in 2022 and took cash out and used the money for a rental home refi. So this is called mixed -use mortgage. A portion is home acquisition debt and a portion is home equity debt used for investment (?). Assume that everything is less that the $1M limit and is not grandfathered debt before 1987.

Say that I did the refi Jan 1 (to make it simpler), the new loan was $500k, and $150k was applied as home acquisition debt and $350k was applied to the rental home. The original mortgage for the home acquisition was $400k.

According to pub 936, I first need to figure out in Part I worksheet, the maximum loan amount I can attribute to home acquisition debt. That seems straightforward. Since the refi, I had $150k of home acquisition debt, that is the amount I ccan get on line 11 as the qualified loan limit. (Pub 936 says I need to pay off the non-acquisition debt first, so all my principle payments go to paying off the $350k, so in 2022, I havent paid any principle from the $150k of home acquisition debt.)

Part II, deductiible home mortgage interest is where I can stuck.

I would think that what makes sense is that the amount of interest I can attribute to the home mortgage to put on Sch A would be the interest rate X $150k and the remainder would be on Sch E such that the sum is what is reported on the 1098. But that isnt how the part II worksheet says. Line 12 says to use the mixed use mortgage instructions, which say to add grandfathered debt and home acquisition debt and enter in line 12. Since the $150k hasnt changed, that is entered in line 12. Then it says if this is the same as the qualified loan limit (which it is), then all the interest is deductibe as home mortgage in Sch A. This doesnt make sense. It would make sense if line 12 included the home equity portion but pub 936 specifically doesnt include that.

What dont I understand or is Pub 936 wrong for line 12?

Not A Product Question

Best answer by NCPERSON1

you are on the right track...I assume that you purchased your home prior to Dec, 2017.

I assume what you are stating is you took out a $500,000 loan collateralized by your primary residence, paying off the original mortgage of $150,000 and used the $350,000 of cash out to buy a rental property; there is no debt on the rental property.

Line 1: 0

Line 2: 150,000

Line 3: $1,000,000

Line 4: $1,000,000

Line 5: $150,000

Linr 6: $150,000

Line 7: $0

line 8: $750,000

line 9: $750,000

Line 10: $150,000

Line 11: $150,000

Line 12: $150,000

"If line 11 is equal to or more than line 12, stop here. All of your interest on all the mortgages included on line 12 is deductible as home mortgage interest on Schedule A"

read the instructions closely! The interest RELATED TO THE $150,000 is all deductible. it says the interest related to the mortgages on Line 12 is deductible, not that ALL the interest related to the $500,000 is deductible!

and you are correct that the Schedule A deductible interest is $150,000 times the interest rate. And it will be that simple until the total mortgage amortizes down to $150,000 at which time all the interest will be SChedule A deductible.

if you sell the rental before the mortgage amortizes down to $150,000 (and not buy another rental property with the proceeds), the interest related to the mortgage part that exceeds $150,000 is not deductible ANYWHERE.

N

NCPERSON1Answer

you are on the right track...I assume that you purchased your home prior to Dec, 2017.

I assume what you are stating is you took out a $500,000 loan collateralized by your primary residence, paying off the original mortgage of $150,000 and used the $350,000 of cash out to buy a rental property; there is no debt on the rental property.

Line 1: 0

Line 2: 150,000

Line 3: $1,000,000

Line 4: $1,000,000

Line 5: $150,000

Linr 6: $150,000

Line 7: $0

line 8: $750,000

line 9: $750,000

Line 10: $150,000

Line 11: $150,000

Line 12: $150,000

"If line 11 is equal to or more than line 12, stop here. All of your interest on all the mortgages included on line 12 is deductible as home mortgage interest on Schedule A"

read the instructions closely! The interest RELATED TO THE $150,000 is all deductible. it says the interest related to the mortgages on Line 12 is deductible, not that ALL the interest related to the $500,000 is deductible!

and you are correct that the Schedule A deductible interest is $150,000 times the interest rate. And it will be that simple until the total mortgage amortizes down to $150,000 at which time all the interest will be SChedule A deductible.

if you sell the rental before the mortgage amortizes down to $150,000 (and not buy another rental property with the proceeds), the interest related to the mortgage part that exceeds $150,000 is not deductible ANYWHERE.

W

whodiiniAuthor

Thank you! Answer makes sense - have 2 followup questions

1. In the context of your answer, how would I report the interest on the federal tax return? In the above example, I would have to allocate all the interest in sch E and none to the home acquisition portion. I receive a 1098. Say that it shows interest of $25k. If I have a1098 form in turbotax reporting $25k in interest, it autopopulates $25k in sch A. Do I override the $25k in the 1098? Then there is an inconsistency in the reported 1098 and what I report. I know how to enter interest in Sch E, so that is straightforward.

2. It turns out that CA tax law is different than federal in that CA tax law allows you to deduct up to $100k of home equity debt as acquisition debt. Q 2a) When it says you can deduct up to $100k of home equity debt, do you have to? If it is optional, then it is easier to keep one set of books instead of 2 and keep CA state consistent with CA. Q 2b) There is an advantage of deducting $100k as home equity debt because that increases the amount that can be itemized in CA. In the above example, the interest of $25k would be divided between $5k as CA home acquisition debt/equity debt and $20k rental prop debt. Would like to know if it is optional or required to take the deduction of $100k.

Thanks!

N

NCPERSON1

1) yes, just override the 25k. there is no inconsistency. If you are ever audited by the IRS, you have the documentation to show how you deducted some interest on Sch A and the rest on Scd E.

2. No you don't have to. Taxing authories "love it" when you don't take deductions entited to you. While I am not really familiar with CA taxes, you may be better off following the CA rules. Here's why: on the federal return, you are likely a passive investor, so your losses are only deductible up to a point (the rest are deferred to a future year). If CA works similarly, then you would want to take the deduction as a personal deduction and not a real estate deduction so that you can take the deduction now versus years into the future. Something to look into.