| Personal Residence / Converting nondeductible personal interest into deductible expense—home equity loan |  |
|||
|
Many individuals and families
(particularly those with school-age children), use personal loans or
credit cards to buy cars or vans, finance private schooling, take
vacations, etc. If you are making significant
payments on these kinds of debts, you know you can't deduct the
"personal interest." That means you are paying the interest
portion with after-tax dollars (and perhaps at very high rates as well).
There's a way to convert your
nondeductible interest payments into deductible expense. You can get
this tax break if you own your own home. Specifically, you can take out a
home equity loan (in the normal way, from your bank for example) and use
the proceeds to pay off your nondeductible debts. You will probably be
paying at a lower rate, since many lenders are charging near prime on
these loans. And the interest payments will be deductible even though
you don't use the loan for anything connected with the house . Of course, before you borrow against
the equity in your personal residence, you should be certain that you
actually get the tax deduction benefit. As always, there are various
technical restrictions and limits that may apply, depending on your
particular tax facts and circumstances. First, the loan must be
"secured" by your residence. That is, the lender must have a
mortgage interest in it. Don't confuse so-called "home
improvement" loans, which are just one type of personal loan, with
qualifying "home equity" loans. The interest on an unsecured
home improvement loan isn't deductible. Second, the residence securing the
debt must either be your principal residence (essentially, the home you
live in most of the year) or a single second residence, for example, a
vacation home which you use for at least part of the year. (If you own
more than one "second" residence, a home equity loan secured
by only one of them (your choice) can qualify.) Third, although, as noted above,
home equity debt doesn't have to be used on the home, there are limits
on the amount of debt than can qualify. Specifically, qualifying home
equity debt can't exceed the lesser of (a) $100,000, or (b) your equity
in the home (specifically, the fair market value of the home at the date
of the loan reduced by the "acquisition debt," generally, your
first mortgage). For example, say a taxpayer takes out a first mortgage
to buy a home worth $300,000. Later, when the first mortgage is still
$200,000, but because of a downturn in the real estate market the value
of the home has declined to $275,000, the taxpayer takes out a home
equity loan to reduce his credit card debts and pay for his daughter's
wedding. The taxpayer will only be able to deduct the interest on a
maximum of $75,000 of any home equity loan he takes out ($275,000 fair
market value minus $200,000 acquisition debt), even though the lender
may be willing to make a loan in excess of the taxpayer's $75,000 equity
in the home. Thus, if the taxpayer took out a $100,000 home equity loan,
only 75% of the interest on the loan would be deductible. Note that a home equity lender is required to give you an information return (Form 1098) reporting the interest you paid, but that form doesn't show the deductible percentage, just the total amount of interest paid. |
Home
Tax topics |
|||