Excess home mortgage interest.

• Author: Bakale, Anthony

In many areas of the U.S., real estate prices are escalating at an annual rate of 10-20%. Many personal residences now have a price tag in the millions of dollars. As a result, the mortgages on these residences could also be millions of dollars.

Sec. 163(h)(3)(B) imposes a $1 million limit on home acquisition indebtedness ($500,000 if married filing separately). The following example and Exhibit 1 show how to calculate the mortgage interest paid in excess of this limit.

Exhibit 1: Worksheet to Figure Qualified Loan Limit and Deductible Home Mortgage Interest (from IRS Pub. 936, Home Mortgage Interest) Part 1: Qualified loan limit 1. Average balance of grandfathered debt (before 10/14/87) $ -0- 2. Average balance of mortgage principal: (beginning + ending)/2 1,591,874 3. Maximum loan balance of $1,000,000 1,000,000 4. Larger of the amount on line 1 or on line 3 1,000,000 5. Add the amounts on lines 1 and 2 1,591,874 6. The smaller of the amount on line 4 or line 5 1,000,000 7. Enter the maximum of $100,000 allowed for home equity debt 100,000 8. Add the amounts on lines 6 and 7. This is the qualified loan limit. 1,100,000 Part II: Deductible home mortgage interest 9. The total of the average balances of all mortgages on all qualified homes $1,591,874 10. Total amount of interest paid during the year (refer to amortization schedule) 111,485 11. Divide the amount an line 8 by the amount on line 9 x0.691 12. Multiply the amount on line 10 by the decimal amount on line 11. This is the allowable home mortgage interest deduction. $ 77,036 13. Subtract the amount on line 12 from the amount on line 10. This is not home mortgage interest. $ 34,449 The question becomes how a practitioner should treat the mortgage interest of $34,449 that S paid in excess of the limit. Sec. 163(h)(1) disallows a deduction for personal interest. Sec. 163(h)(2) defines personal interest as any interest paid other than:

1. Interest paid on a trade or business debt;

2. Investment interest;

3. Interest taken into account in computing income or loss from a passive activity;

4. Qualified residence interest;

5. Interest on an unpaid portion of estate tax (under Sec. 6163); and

6. Interest on qualified education loans.

   If the residence meets certain criteria, S may be able to deduct the $34,449 as investment interest on Schedule A.

   Sec. 163(d)(5)(A) defines property held for investment as:

1. Property that produces interest, dividends, annuities or royalties not derived in the...