Limitations on Home Mortgage Interest Deductions

Home mortgage interest deductions have certain limitations relating to home acquisition and home equity indebtedness.

The first limitation is based upon the limit for loans obtained in the acquisition to purchase, build or substantially improve a residence.  This type of debt is known as home acquisition debt.  There also exists another limit for loans secured by a qualified residence where the funds are used for other purposes, known as home equity debt. 

The law allows taxpayers to deduct interest on two categories of indebtedness secured by their residences, up to $1,000,000 in acquisition debt as it relates to the interest charges thereto.  Acquisition indebtedness is used to acquire, construct, or substantially improve a residence and cannot exceed $1,000,000 in regards to deductibility of the interest attached thereto.  Home equity indebtedness is any debt other than acquisition indebtedness and cannot exceed $100,000 in debt and the interest charges attached to that type of debt. 

Home Acquisition Debt is any loan whose purpose is to acquire, to construct, or to substantially improve a qualified home.  It also must be secured by that home.

Taxpayers may deduct interest on the loan balance of up to $1,000,000 of home acquisition debt secured by a qualified primary or secondary residence.  The limit is reduced to $500,000 for taxpayers who are married filing separately.

Home Equity Debt is any loan secured by a qualified residence whose purpose is other than to acquire, construct or substantially improve a qualified home.  Acquisition loans that exceed the $1,000,000 limit may also qualify as home equity indebtedness.

The interest deduction from a home equity loan is limited.  Taxpayers can generally deduct interest paid on the first $100,000 of a home equity loan.  The home equity debt limit is reduced to $50,000 for taxpayers who are married filing separately.

If the home equity loan was used to improve the taxpayer’s first or second home - or to purchase a second home – the taxpayer may be eligible for a deduction on an amount up to $1 million of debt as to the interest thereto.  There is a problematic catch in these calculations in a down market as we are currently experiencing in that the deduction for home equity interest may be reduced below the $100,000 limit if the indebtedness exceeds the fair market value of your home.