Do You Owe More Than $1 Million on Your Home? If So, the IRS May be Calling You

Homeowners who owe more than $1 million on their homes are under intensified scrutiny by the IRS now. Why? Because of so much confusion over deducting the interest on those over $1 million mortgages. And you can do the math — if your mortgage is more than a million, you are likely deducting a boatload of mortgage interest so pay attention because this could mean good deduction news, something we need a whole lot more of right now. I’d say only your CPA knows for sure but that may not really be the case!

Here’s the deal — as is usual, the tax code is so dang complex everyone is confused, even the IRS themselves and those advising us, CPA’s.  At issue is how much interest can be deducted, and it is based on what kind of debt the homeowner holds. I will tell you that the Alternative Minimum tax can make this a moot question for many, which is frustrating.

Tax rules distinguish between two kinds of home debt. There is home acquisition debt, which is a loan used to acquire, construct or substantially improve a qualified home, and is secured by the home. This would be your mortgage.

Then there is home equity debt, which is any other kind of loan that is also secured by the home, but used to pay off credit card debt or for general consumer spending.

The controversy centers on how this was all interpreted. Some tax advisers and agents were telling clients it was acceptable to deduct all interest on a single mortgage of up to $1.1 million. Others said no,  the limit for mortgages was $1 million, but they could also deduct interest on another $100,000 (up to $100,000) in a home equity loan.

IRS said last spring acquisition loans over $1 million may also qualify as home equity indebtedness. And the taxpayer can deduct interest on the full $1.1 million, even if he has only one loan.

But throw a few re-fi’s into the mix, and the rules can get “complex”. Or second homes. If a taxpayer owns several homes, say a house in upstate New York and a condominium in New York, they may also be subject to paying New York state and city income tax if they are there for more than 180 days/year.

There’s a reason why we call this blog second shelters: tax rules generally allow deductions on a first and second home, but not a third or more. Of course, most folks pop those into limited liability partnerships, especially if they are income-producing, and the entity files a tax return that flows down to the taxpayer.

And if you are thinking ha, it’s those rich SOBs again, let them pay up… think again. Many people buy in areas where home prices are not what they are in Texas, and they have no choice but to take on huge mortgages. I am also finally reading Michael Lewis’ The Big Short, which is amazing and spells out how banks wanted to over-extend loans to consumers, many of them 100% loans on, yes, million dollar properties.