Editor’s Note: This article is part of our 2012 Tax Tips series. Robert Flach is an expert with almost 40 years of experience as a tax professional and also blogs as The Wandering Tax Pro.
NEW YORK (MainStreet) – Do you own a home – or multiple residences? You probably already know that interest on debt secured by a personal residence can be deducted on Schedule A, but unlike real estate tax, you can only deduct interest on two properties at a time.
For instance, let’s say you own a personal residence in New Jersey and two vacation properties – one in Florida and one in the Poconos. If all three of the properties have a mortgage, you can only deduct the mortgage interest on two of the properties.
There are three kinds of deductible mortgage interest with some key differences. Here is a breakdown of each:
Debt acquired after Oct. 13, 1987, to buy, build or “substantially improve” (add value to the home, prolong the home’s useful life, or adapt the home to new uses) the property is considered acquisition debt. You can deduct in full the interest on up to $1 million in acquisition debt ($500,000 if filing separately).
Home Equity Debt
Home equity debt refers to debt secured by a residence not used to buy, build or substantially improve the property. There is no restriction or limit on what the money can be used for. You can use the borrowings to buy a car, pay for college or a wedding, or pay down credit cards. You are only allowed to deduct interest on up to $100,000 of home equity debt ($50,000 if filing separate). If you have total home equity debt of $150,000 and the interest on this debt for the year is $9,000, you can only deduct $6,000 ($100,000 divided by $150,000 x $9,000).
Grandfathered debt is debt incurred on or before Oct. 13, 1987 and secured by a personal residence on Oct. 13, 1987 and thereafter, regardless of what the proceeds of the borrowing was used for. Even if refinanced after Oct. 13, 1987, grandfathered debt is considered to be “acquisition debt” and is fully deductible. It is not subject to the $1 million limit.