With interest rate being low and everyone trying to refinance the mortgage and cash out – you may want to find out if your mortgage interest deduction on your tax return will be affected.
IRC 163 defines qualified mortgage interest (interest you can deduct if you itemize on Schedule A) as interest paid or accrued during the taxable year on
1. Acquisition indebtedness, which is a loan used to acquire, build, or substantially improve a residence. Interest on up to $1,000,000 such acquisition indebtedness is deductible for taxpayers who itemize their deductions.
2. Home equity indebtedness which is any kind of borrowing against your residence that is not used to acquire, build, or substantially improve that particular residence. It includes the typical “home equity line of credit,” as well as the cash-out from a refinance that is not used to substantially improve the home(but may be used to pay your credit card debt, car loan and so on). Interest on up to $100,000 of home equity indebtedness is deductible.
Note that a taxpayer who is subject to the AMT is not allowed the deduction of interest on home equity indebtedness that is not used to acquire, build, or substantially improve the residence.
Revenue Ruling 2005-11 provides an interesting analysis on this issue and every person refinancing and subject to AMT must understand this.