Interest on home-equity indebtedness.

• Author: Kiouressis, Assimina D.

The IRS recently released Rev. Rul. 2010-25 to address whether acquisition indebtedness incurred by a taxpayer to acquire, construct, or substantially improve a qualified residence can constitute home-equity indebtedness to the extent it exceeds $1 million (subject to the applicable dollar and fair market value limitations imposed on home-equity indebtedness by Sec. 163(h)(3)(C)). As a result, the IRS ruled that a taxpayer can deduct as qualified residence interest up to $1.1 million of the debt securing the purchase of a taxpayer's principal residence.

Background

While personal interest is nondeductible, qualified residence interest, which includes interest on acquisition indebtedness and home-equity indebtedness, is generally deductible. Acquisition indebtedness is indebtedness incurred to buy, build, or substantially improve an individual's qualified residence that is secured by the residence (Sec. 163(h)(3)(B)(i)). Sec. 163(h)(3)(B)(i) provides that the total amount treated as acquisition indebtedness cannot exceed $1 million for any period ($500,000 for a married individual filing separately), and any indebtedness in excess of $1 million is not acquisition indebtedness.

Sec. 163(h)(3)(C)(i) provides that home-equity indebtedness for any period cannot exceed $100,000 ($50,000 for a married individual filing separately). Home-equity indebtedness is indebtedness other than acquisition indebtedness secured by the taxpayer's principal or secondary residence, to the extent the aggregate amount of the debt does not exceed the excess of the fair market value of the residence over the amount of acquisition indebtedness. Unlike acquisition indebtedness, the proceeds of home-equity indebtedness generally may be used for any purpose without affecting deductibility of the interest.

Rev. Rul. 2010-25 discusses a factual scenario in which an unmarried individual purchases a principal residence for $1,500,000 in 2009 with a cash down payment of $300,000 and a bank loan of $1,200,000 secured by the residence. In 2009, the taxpayer pays interest that accrues on the indebtedness during that year, and there is no other debt outstanding that is secured by the principal residence. The ruling concludes that the taxpayer may deduct the interest paid on the first $1 million of the original loan balance because it is considered acquisition indebtedness under Sec. 163(h)(3)(B). Under the ruling, pursuant to Sec. 163(h)(3)(C), the taxpayer may also deduct the...