How to Use the Investment Interest Deduction for Home Loan Balances Greater than $750,000
HOW AND WHEN TO USE THE INVESTMENT INTEREST DEDUCTION.
The IRS allows you to deduct the interest paid on loans used for investment purposes. The investment interest deduction is useful if you want to use a mortgage that's bigger than $750,000 on a primary or vacation home, and you otherwise can pay cash. That's because you can only deduct the interest on combined mortgage balances up to $750,000 as qualified residence home mortgage interest.
For example, assume you want to buy a $2M primary home and you can pay cash for the property. If you take out a $1.5M mortgage and use the loan proceeds for investment purposes, you'd be able to deduct the interest on the entire loan amount as investment interest instead of being subject to the $750,000 cap for qualified residence home mortgage interest. Of course, some rules need to be followed.
HOW TO PROVE THE FUNDS ARE BEING USED FOR INVESTMENT PURPOSES.
You must trace the loan proceeds directly to the investment being purchased to qualify for the investment interest deduction. Here are two ideas you and your financial advisor may want to consider using the example above:
- Idea #1: Take out a $750,000 mortgage to purchase the home, and then after the closing, refinance into a larger $1.5M mortgage, depositing the cash proceeds into your investment account. In this case, the interest on $750,000 of the $1.5M loan would be deductible as home mortgage interest, while the interest on the remaining $750,000 would be deductible as investment interest. Alternatively,
- Idea #2: Pay cash for the property and then take out a mortgage at a later date unrelated to the home purchase. In this case, the interest on the entire mortgage would be deductible as investment interest if you use the cash proceeds for investment purposes.
INVESTMENT INTEREST IS ONLY DEDUCTIBLE AGAINST INVESTMENT INCOME.
If you don't have investment income this year, the interest isn't deductible on your tax returns this year. In that case, you would carry over the deduction into a future tax year and claim it once you have investment income.
BE AWARE OF INVESTMENT RESTRICTIONS.
It's important to note that the loan proceeds can't be used to invest in single-premium life insurance, annuities, or tax-free investments such as municipal bonds. That's because investment interest is only deductible against taxable investment income. There are other restrictions as well, so be sure to talk to a CPA for specific advice about your situation.
PLEASE NOTE: THIS ARTICLE IS PROVIDED FOR INFORMATIONAL PURPOSES ONLY AND DOES NOT CONSTITUTE LEGAL, TAX, OR FINANCIAL ADVICE. PLEASE CONSULT WITH A QUALIFIED TAX ADVISOR FOR SPECIFIC ADVICE ABOUT YOUR SITUATION. FOR MORE INFORMATION ON ANY OF THESE ITEMS, PLEASE REFERENCE IRS PUBLICATION 946 and IRS PUBLICATION 550.
That's the maximum loan balance eligible for the qualified home mortgage interest deduction.
Source: Momentifi