Mortgage interest is deductible in two main ways, but primarily limited to your priamry residence and qualifying second home. One is acquisition indebtedness and the other is home equity indebtedness. Failure to understand these definitions may have put many home owners in jeopardy of IRS penalties. While I could just quote IRS definitions, I do not want to put you to sleep as this is an extremely important topic.

Acquisition Indebtness is the amount of debt you incur when you first purchase your home, minus the amount of principal you have paid down. This amount currently is limited to the first $1 million of your mortgage balance(s). The only way that acquisition indebtness can increase is if you have or will be completing qualified home improvements. If you did improvements within the last two years, you can still refinance and count that amount as part of your acquisition indebtness.

Home Equity Indebtedness is a little simpler to explain. It is the amount of your mortgage(s) exceeding your acquisition indebtness. Currently home equity indebtedness is limited to $100,000.

The problem is that if you did a cash out refinance of more than $100,000, you cannot deduct the interest on the amount beyond $100,000. This is because of the Home equity indebtness limitation. Most people believe that they can take out $100,000 beyond the amount of their original mortgage, which is incorrect. here is an example of what I mean...

You buy a $250,000 home using a mortgage of $200,000. You were in South Florida, so your home is now worth $500,000 and you have diligently paid your mortgage down to $100,000. You find yourself needing cash and decide to do a cash-out refinance. You decide to refinance for a new mortgage of $300,000. How much is deductible?

Well, in this case, your acquistion indebtedness is $100,000, your allowable home equity indebtedness is $100,000, so you can only deduct interest off the first $200,000. The other $100,000 is non-deductible in this case.

What about if you spent $50,000 to build a pool 2 years ago and paid cash for it? Well then you could add the $50,000 to your acquisition indebtedness and then deduct $250,000 of the $300,000 instead.

There are ways to legally exceed these limitations, but that will be in a later blog. Also, remember that if you normally bump up against the Alternative Minimum Tax (AMT) limitations, you may not be able to fully deduct your mortgage interest anyways.

About the author: Robert D. Ashby is President of Solid Rock Mortgage, a licensed Mortgage Brokerage Business in the state of Florida. He has been in the financial services business since 1997 and obtained his Series 6 and 63 Securities Licenses as well as Life and Health Insurance Licenses in the state of Virginia. He moved to Florida in 2002 and decided to focus solely on mortgages, obtaining his Mortgage Broker License for Florida in 2003 and then opening Solid Rock Mortgage in 2004. He has become Floridas first Certified Mortgage Planning Specialist and Floridas Debt and Equity Management Expert.

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