Election not to treat debt as secured by a qualified residence.The mortgage interest deduction Mortgage interest deduction A federal tax deduction for interest paid on a mortgage used to acquire, construct, or improve a residence. has been part of U.S. tax policy since the 1913 Code. However, many taxpayers cannot deduct de·duct v. de·duct·ed, de·duct·ing, de·ducts v.tr. 1. To take away (a quantity) from another; subtract. 2. To derive by deduction; deduce. v.intr. all mortgage interest paid. Proper planning can maximize the mortgage interest deduction and can be a useful strategy in overall tax planning Tax planning Devising strategies throughout the year in order to minimize tax liability, for example, by choosing a tax filing status that is most beneficial to the taxpayer. . Overview Interest is the amount contracted for to pay for the use, forbearance Refraining from doing something that one has a legal right to do. Giving of further time for repayment of an obligation or agreement; not to enforce claim at its due date. A delay in enforcing a legal right. detention of money. Sec. 163(a) provides a general rule that all interest paid or accrued ac·crue v. ac·crued, ac·cru·ing, ac·crues v.intr. 1. To come to one as a gain, addition, or increment: interest accruing in my savings account. 2. in the tax year on debt deductible That which may be taken away or subtracted. In taxation, an item that may be subtracted from gross income or adjusted gross income in determining taxable income (e.g., interest expenses, charitable contributions, certain taxes). , but there are numerous exceptions. Usually, under Sec. 163(h) for a taxpayer other than a corporation, no deduction is allowed for personal interest paid or accrued during the tax year. Sec. 163(d) limits a noncorporate taxpayer,s deduction for investment interest to net investment income for the tax year. 163 (d)(2) permits an unlimited carryforward of any amounts so disallowed. Interest disallowed may be deducted de·duct v. de·duct·ed, de·duct·ing, de·ducts v.tr. 1. To take away (a quantity) from another; subtract. 2. To derive by deduction; deduce. v.intr. in the succeeding tax year the extent the taxpayer has investment income in that year. Interest attributable to a trade or business or to property held for the production of income may be deducted by itemizers and nonitemizers alike, but is subject to the various ancillary restrictions, such as those governing passive activity losses (Sec. 469) and at-risk amounts (Sec. 465). Trade or business interest may also be subject to capitalization under Sec. 263A(f). Interest on certain student loans is partial deductible under Sec. 221. Under Sec. 163(h)(2)(d), "qualified residence interest" (QRI QRI Tone (T1 to T9) QRI Qualitative Reading Inventory (reading assessment) QRI Qualitative Requirements Information QRI Quality Results Inc (Philippines) QRI Queue Response Indicator ) includes interest paid or accrued during the tax year on (1) acquisition debt on a taxpayer's qualified residence or (2) home-equity debt on a taxpayer's qualified residence. QRI There are two types of QRI, according to according to prep. 1. As stated or indicated by; on the authority of: according to historians. 2. In keeping with: according to instructions. 3. Sec. 163(h)(3)(A), on (1) "acquisition" debt and (2) "home equity" debt. Acquisition debt: Sec. 163(h)(3)(B) defines acquisition debt as any debt incurred in acquiring, constructing or substantially improving a qualified residence and secured by it. This term also includes debt secured by a qualified residence and incurred to refinance Refinance 1. When a business or person revises their payment schedule for repaying debt. 2. Replacing an older loan with a new loan offering better terms. Notes: When a business refinances they typically extend the maturity date. acquisition debt; however, such debt is limited to the amount of debt refinanced at the time of the loan. An overall dollar limit under Sec. 163(h)(3)(B)(ii) caps the "aggregate amount" of acquisition debt at $1 million for any period ($500,000 for a married taxpayer filing separately); this limit is not indexed for inflation. "Aggregate amount" probably means the total debt secured by one or more qualified residences, not just that secured by any one qualified residence. Home-equity debt: Sec. 163(h)(3)(C) defines home-equity debt as any debt (other than acquisition debt) secured by a qualified residence, to the extent it does not exceed the residence's fair market value reduced by any outstanding acquisition debt the residence secures. The aggregate home-equity debt for any period may not exceed $100,000 ($50,000 for a married taxpayer filing separately). What is a Qualified Residence? Sec. 163(h)(4)(A) defines "qualified residence" to mean either the taxpayer's principal or a second residence. A "second residence" is a residence the taxpayer uses as such and for which the taxpayer elects such treatment. A taxpayer cannot have more than one principal or second residence at a time. According to Temp. Regs. Sec. 1.16310T(p)(3)(ii) and Sec. 163(h)(4)(B), a residence is generally a house, condominium condominium In modern property law, individual ownership of one dwelling unit within a multidwelling building. Unit owners have undivided ownership interest in the land and those portions of the building shared in common. , cooperative, mobile home, boat or house trailer that contains a sleeping space, toilet and cooking facilities. A residence does not include personal property (e.g., furniture) that is not a fixture under local law. If a residence is rented during the tax year, it is a residence only if the taxpayer uses it as such within the meaning of Sec. 280A(d) (i.e., he or she uses it for personal purposes for the greater of (1) 14 days or (2) 10% of the number of days during the the tax year for which it is rented at a fair rental). The QRI dollar limits on deductions prescribed under Sec. 163(h)(3)(B)(ii) and (C)(i) bar taxpayers from deducting excess interest payments. QRI included in itemized deductions Itemized Deduction A deduction from a taxpayer's taxable adjusted gross income that is made up of deductions for money spent on certain goods and services throughout the year. also may be limited in the case of high-income taxpayers. There are certain circumstances in which home-equity debt proceeds could be used to allow interest to be deductible under other Code provisions. Temp. Regs. Sec. 1.163-10T(o)(5) provides that a taxpayer may elect to treat home-equity debt as not secured by a residence. Election By making tiffs election, the taxpayer frees the debt from the QRI dollar limit, making it available for another interest deduction Interest deduction An interest expense, such as interest on a margin account, that is allowed as a deduction for tax purposes. , if applicable. Thus, if interest is deductible regardless of whether it is QRI, electing out of QRI treatment preserves the deduction for interest on other debts deductible only if it is QRI. For purposes of Temp. Regs. Sec. 1.16310T(o)(5), a taxpayer may elect to treat any debt secured by a qualified residence as not secured by such residence. The election is effective for the tax year for which made and for all subsequent tax years, unless revoked with IRS An abbreviation for the Internal Revenue Service, a federal agency charged with the responsibility of administering and enforcing internal revenue laws. consent. While deducting the interest on the appropriate forms and/or lines is sufficient under the regulations to perfect the election, taxpayers are advised to make the election in a separate statement attached to the return. Example: J has two outstanding debts secured by a qualified residence. For debt 1, the principal balance is $60,000; J used the proceeds to purchase machinery for his business. Debt 2's principal balance is $70,000; J used the proceeds to purchase a personal-use automobile. Both debts qualify as home-equity debt, but their aggregate amount ($130,000) exceeds the $100,000 cap. Thus, interest on only the first $100,000 of the two debts would be deductible QRI. The interest on debt 1 is not subject to any of the limits on interest deductibility and is deductible regardless of whether it is QRI. The interest on debt 2, however, is personal and is deductible only if it is QRI. Under these circumstances, if J elects to treat debt 1 as not secured by a qualified residence, the interest remains frilly frill n. 1. A ruffled, gathered, or pleated border or projection, such as a fabric edge used to trim clothing or a curled paper strip for decorating the end of the bone of a piece of meat. 2. deductible, and all of debt 2 will qualify as home-equity debt, fully deductible as QRI; see Exhibit 1 on p. 668. If J fails to make the election, $30,000 of his aggregate debt will fail to qualify as home-equity debt; the interest on such debt will not be deductible. Conclusion Taxpayers need to be aware of all possible tax implications for borrowing on homes and the deductibility of the related interest, so as to maximize the tax benefit. Exhibit 1: Election statement under Temp. Regs. Sec. 1.163-10T(o)(5) to treat debt as not secured by a qualified residence Taxpayer name: J Soc. Sec. No.: 999-99-9999 Form 1040, tax year ending 12/31/XX The taxpayer elects to treat $60,000 of home-equity debt, the proceeds of which were used to purchase machinery for his business, as trade or business debt. The interest on this debt for tee tax year was $10,543 and is claimed on Line 16b of Schedule C. FROM PAWAN AGARWAL, PATRICK KOPPLIN, CPA (Computer Press Association, Landing, NJ) An earlier membership organization founded in 1983 that promoted excellence in computer journalism. Its annual awards honored outstanding examples in print, broadcast and electronic media. The CPA disbanded in 2000. , AND BRAD WHATLEY, CPA, PKF PKF Peace Keeping Force PKF Pannell Kerr Foster (accounting firm) PKF Park Falls, Wisconsin (Airport Code) TEXAS, HOUSTON, TX |
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