Publication 936 |
2001 Tax Year |
Part II. Limits on Home Mortgage Interest Deduction
This part of the publication discusses the limits on deductible
home mortgage interest. These limits apply to your home mortgage
interest expense if you have a home mortgage that does not fit into
any of the three categories listed at the beginning of Part I
under Fully deductible interest.
Your home mortgage interest deduction is limited to the interest on
the part of your home mortgage debt that is not more than your
qualified loan limit. This is the part of your home mortgage debt that
is grandfathered debt or that is not more than the limits for home
acquisition debt and home equity debt. Table 1 can help you
figure your qualified loan limit and your deductible home mortgage
interest.
Home Acquisition Debt
Home acquisition debt is a mortgage you took out after October 13,
1987, to buy, build, or substantially improve a qualified home (your
main or second home). It also must be secured by that home.
If the amount of your mortgage is more than the cost of the home
plus the cost of any substantial improvements, only the debt that is
not more than the cost of the home plus improvements qualifies as home
acquisition debt. The additional debt may qualify as home equity debt
(discussed later).
Home acquisition debt limit.
The total amount you can treat as home acquisition debt at any time
on your main home and second home cannot be more than $1 million
($500,000 if married filing separately). This limit is reduced (but
not below zero) by the amount of your grandfathered debt (discussed
later). Debt over this limit may qualify as home equity debt (also
discussed later).
Refinanced home acquisition debt.
Any secured debt you use to refinance home acquisition debt is
treated as home acquisition debt. However, the new debt will qualify
as home acquisition debt only up to the amount of the balance of the
old mortgage principal just before the refinancing. Any additional
debt is not home acquisition debt, but may qualify as home equity debt
(discussed later).
Mortgage that qualifies later.
A mortgage that does not qualify as home acquisition debt because
it does not meet all the requirements may qualify at a later time. For
example, a debt that you use to buy your home may not qualify as home
acquisition debt because it is not secured by the home. However, if
the debt is later secured by the home, it may qualify as home
acquisition debt after that time. Similarly, a debt that you use to
buy property may not qualify because the property is not a qualified
home. However, if the property later becomes a qualified home, the
debt may qualify after that time.
Mortgage treated as used to buy, build, or improve home.
A mortgage secured by a qualified home may be treated as home
acquisition debt, even if you do not actually use the proceeds to buy,
build, or substantially improve the home. This applies in the
following situations.
- You buy your home within 90 days before or after the date
you take out the mortgage. The home acquisition debt is limited to the
home's cost, plus the cost of any substantial improvements within the
limit described below in (2) or (3). (See Example
1.)
- You build or improve your home and take out the mortgage
before the work is completed. The home acquisition debt is limited to
the amount of the expenses incurred within 24 months before the date
of the mortgage.
- You build or improve your home and take out the mortgage
within 90 days after the work is completed. The home acquisition debt
is limited to the amount of the expenses incurred within the period
beginning 24 months before the work is completed and ending on the
date of the mortgage. (See Example 2.)
Example 1.
You bought your main home on June 3 for $175,000. You paid for the
home with cash you got from the sale of your old home. On July 15, you
took out a mortgage of $150,000 secured by your main home. You used
the $150,000 to invest in stocks. You can treat the mortgage as taken
out to buy your home because you bought the home within 90 days before
you took out the mortgage. The entire mortgage qualifies as home
acquisition debt because it was not more than the home's cost.
Example 2.
On January 31, John began building a home on the lot that he owned.
He used $45,000 of his personal funds to build the home. The home was
completed on October 31. On November 21, John took out a $36,000
mortgage that was secured by the home. The mortgage can be treated as
used to build the home because it was taken out within 90 days after
the home was completed. The entire mortgage qualifies as home
acquisition debt because it was not more than the expenses incurred
within the period beginning 24 months before the home was completed.
This is illustrated by Figure C.
Date of the mortgage.
The date you take out your mortgage is the day you receive the loan
proceeds. This is generally the closing date. You can treat the day
you apply in writing for your mortgage as the date you take it out.
However, this applies only if you receive the loan proceeds within a
reasonable time (such as within 30 days) after your application is
approved. If a timely application you make is rejected, a reasonable
additional time will be allowed to make a new application.
Cost of home or improvements.
To determine your cost, include amounts paid to acquire any
interest in a qualified home or to substantially improve the home.
The cost of building or substantially improving a qualified home
includes the costs to acquire real property and building materials,
fees for architects and design plans, and required building permits.
Substantial improvement.
An improvement is substantial if it:
- Adds to the value of your home,
- Prolongs your home's useful life, or
- Adapts your home to new uses.
Repairs that maintain your home in good condition, such as
repainting your home, are not substantial improvements. However, if
you paint your home as part of a renovation that substantially
improves your qualified home, you can include the painting costs in
the cost of the improvements.
Acquiring an interest in a home because of a divorce.
If you incur debt to acquire the interest of a spouse or former
spouse in a home, because of a divorce or legal separation, you can
treat that debt as home acquisition debt.
Part of home not a qualified home.
To figure your home acquisition debt, you must divide the cost of
your home and improvements between the part of your home that is a
qualified home and any part that is not a qualified home. See
Divided use of your home under Qualified Home in
Part I.
Home Equity Debt
If you took out a loan for reasons other than to buy, build, or
substantially improve your home, it may qualify as home equity debt.
In addition, debt you incurred to buy, build, or substantially improve
your home, to the extent it is more than the home acquisition debt
limit (discussed earlier), may qualify as home equity debt.
Home equity debt is a mortgage you took out after October 13, 1987,
that:
- Does not qualify as home acquisition debt or as
grandfathered debt, and
- Is secured by your qualified home.
Example.
You bought your home for cash 10 years ago. You did not have a
mortgage on your home until last year, when you took out a $20,000
loan, secured by your home, to pay for your daughter's college tuition
and your father's medical bills. This loan is home equity debt.
Home equity debt limit.
There is a limit on the amount of debt that can be treated as home
equity debt. The total home equity debt on your main home and second
home is limited to the smaller of:
- $100,000 ($50,000 if married filing separately), or
- The total of each home's fair market value (FMV) reduced
(but not below zero) by the amount of its home acquisition debt and
grandfathered debt. Determine the FMV and the outstanding home
acquisition and grandfathered debt for each home on the date that the
last debt was secured by the home.
Example.
You own one home that you bought in 1998. Its FMV now is $110,000,
and the current balance on your original mortgage (home acquisition
debt) is $95,000. Bank M offers you a home mortgage loan of 125% of
the FMV of the home less any outstanding mortgages or other liens. To
consolidate some of your other debts, you take out a $42,500 home
mortgage loan [(125% × $110,000) - $95,000] with Bank M.
Your home equity debt is limited to $15,000. This is the smaller
of:
- $100,000, the maximum limit, or
- $15,000, the amount that the FMV of $110,000 exceeds the
amount of home acquisition debt of $95,000.
Debt higher than limit.
Interest on amounts over the home equity debt limit (such as the
interest on $27,500 [$42,500 - $15,000] in the preceding
example) generally is treated as personal interest and is not
deductible. But if the proceeds of the loan were used for investment,
business, or other deductible purposes, the interest may be
deductible. If it is, see the Table 1 Instructions for line
13 for an explanation of how to allocate the excess interest.
Part of home not a qualified home.
To figure the limit on your home equity debt, you must divide the
FMV of your home between the part that is a qualified home and any
part that is not a qualified home. See Divided use of your home
under Qualified Home in Part I.
Fair market value (FMV).
This is the price at which the home would change hands between you
and a buyer, neither having to sell or buy, and both having reasonable
knowledge of all relevant facts. Sales of similar homes in your area,
on about the same date your last debt was secured by the home, may be
helpful in figuring the FMV.
Grandfathered Debt
If you took out a mortgage on your home before October 14, 1987, or
you refinanced such a mortgage, it may qualify as grandfathered debt.
To qualify, it must have been secured by your qualified home on
October 13, 1987, and at all times after that date. How you used the
proceeds does not matter.
Grandfathered debt is not limited. All of the interest you paid on
grandfathered debt is fully deductible home mortgage interest.
However, the amount of your grandfathered debt reduces the $1 million
limit for home acquisition debt and the limit based on your home's
fair market value for home equity debt.
Refinanced grandfathered debt.
If you refinanced grandfathered debt after October 13, 1987, for an
amount that was not more than the mortgage principal left on the debt,
then you still treat it as grandfathered debt. To the extent the new
debt is more than that mortgage principal, it is treated as home
acquisition or home equity debt, and the mortgage is a mixed-use
mortgage (discussed later under Average Mortgage Balance in
the Table 1 Instructions). The debt must be secured by the
qualified home.
You treat grandfathered debt that was refinanced after October 13,
1987, as grandfathered debt only for the term left on the debt that
was refinanced. After that, you treat it as home acquisition debt or
home equity debt, depending on how you used the proceeds.
Exception.
If the debt before refinancing was like a balloon note (the
principal on the debt was not amortized over the term of the debt),
then you treat the refinanced debt as grandfathered debt for the term
of the first refinancing. This term cannot be more than 30 years.
Example.
Chester took out a $200,000 first mortgage on his home in 1985. The
mortgage was a five-year balloon note and the entire balance on the
note was due in 1990. Chester refinanced the debt in 1990 with a new
20-year mortgage. The refinanced debt is treated as grandfathered debt
for its entire term (20 years).
Line-of-credit mortgage.
If you had a line-of-credit mortgage on October 13, 1987, and
borrowed additional amounts against it after that date, then the
additional amounts are either home acquisition debt or home equity
debt depending on how you used the proceeds. The balance on the
mortgage before you borrowed the additional amounts is grandfathered
debt. The newly borrowed amounts are not grandfathered debt because
the funds were borrowed after October 13, 1987. See Mixed-use
mortgages under Average Mortgage Balance in the
Table 1 Instructions that follow.
Table 1 Instructions
You can deduct all of the interest you paid during the
year on mortgages secured by your main home or second home in either
of the following two situations.
- All the mortgages are grandfathered debt.
- The total of the mortgage balances for the entire year is
within the limits discussed earlier under Home Acquisition Debt
and Home Equity Debt.
In either of those cases, you do not need Table 1.
Otherwise, you may use Table 1 to determine your
qualified loan limit and deductible home mortgage interest.
Fill out only one Table 1 for both your main and second
home regardless of how many mortgages you have.
Table 1. Worksheet: qualified loan limit
Home equity debt only.
If all of your mortgages are home equity debt, do not fill in lines
1 through 5. Enter zero on line 6 and complete the rest of Table
1.
Average Mortgage Balance
You have to figure the average balance of each mortgage to
determine your qualified loan limit. You need these amounts to
complete lines 1, 2, and 9 of Table 1. You can use the
highest mortgage balances during the year, but you may benefit most by
using the average balances. The following are methods you can use to
figure your average mortgage balances. However, if a mortgage has more
than one category of debt, see Mixed-use mortgages, later,
in this section.
Average of first and last balance method.
You can use this method if all the following apply.
- You did not borrow any new amounts on the mortgage during
the year. (This does not include borrowing the original mortgage
amount.)
- You did not prepay more than one month's principal during
the year. (This includes prepayment by refinancing your home or by
applying proceeds from its sale.)
- You had to make level payments at fixed equal intervals on
at least a semi-annual basis. You treat your payments as level even if
they were adjusted from time to time because of changes in the
interest rate.
To figure your average balance, complete the following worksheet.
1. |
Enter the balance as of the
first day of the year that the mortgage was secured by your qualified
home during the year (generally January 1) |
|
2. |
Enter the balance as of the last
day of the year that the mortgage was secured by your qualified home
during the year (generally December 31) |
|
3. |
Add amounts on lines 1 and
2 |
|
4. |
Divide the amount on line 3
by 2. Enter the result |
|
Interest paid divided by interest rate method.
You can use this method if at all times in 2001 the mortgage was
secured by your qualified home and the interest was paid at least
monthly.
Complete the following worksheet to figure your average balance.
1. |
Enter the interest paid in
2001. Do not include points or any other interest paid in 2001 that is
for a year after 2001. However, do include interest that is for 2001
but was paid in an earlier year |
|
2. |
Enter the annual interest
rate on the mortgage. If the interest rate varied in 2001, use the
lowest rate for the year |
|
3. |
Divide the amount on line 1
by the amount on line 2. Enter the result |
|
Example.
Mr. Blue had a line of credit secured by his main home all year. He
paid interest of $2,500 on this loan. The interest rate on the loan
was 9% (.09) all year. His average balance using this method is
$27,778, figured as follows.
1. |
Enter the interest paid in
2001. Do not include points or any other interest paid in 2001 that is
for a year after 2001. However, do include interest that is for 2001
but was paid in an earlier year |
$2,500 |
2. |
Enter the annual interest
rate on the mortgage. If the interest rate varied in 2001, use the
lowest rate for the year |
.09 |
3. |
Divide the amount on line 1
by the amount on line 2. Enter the result |
$27,778 |
Statements provided by your lender.
If you receive monthly statements showing the closing balance or
the average balance for the month, you can use either to figure your
average balance for the year. You can treat the balance as zero for
any month the mortgage was not secured by your qualified home.
For each mortgage, figure your average balance by adding your
monthly closing or average balances and dividing that total by the
number of months the home secured by that mortgage was a qualified
home during the year.
If your lender can give you your average balance for the year, you
can use that amount.
Example.
Ms. Brown had a home equity loan secured by her main home all year.
She received monthly statements showing her average balance for each
month. She may figure her average balance for the year by adding her
monthly average balances and dividing the total by 12.
Mixed-use mortgages.
A mixed-use mortgage is a loan that consists of more than one of
the three categories of debt (grandfathered debt, home acquisition
debt, and home equity debt). For example, a mortgage you took out
during the year is a mixed-use mortgage if you used its proceeds
partly to refinance a mortgage that you took out in an earlier year to
buy your home (home acquisition debt) and partly to buy a car (home
equity debt).
Complete lines 1 and 2 of Table 1 by including the
separate average balances of any grandfathered debt and home
acquisition debt in your mixed-use mortgage. Do not use the methods
described earlier in this section to figure the average balance of
either category. Instead, for each category, use the following method.
- Figure the balance of that category of debt for each month.
This is the amount of the loan proceeds allocated to that category,
reduced by your principal payments on the mortgage previously applied
to that category. Principal payments on a mixed-use mortgage are
applied in full to each category of debt, until its balance is zero,
in the following order:
- First, any home equity debt,
- Next, any grandfathered debt, and
- Finally, any home acquisition debt.
- Add together the monthly balances figured in (1).
- Divide the result in (2) by 12.
Complete line 9 of Table 1 by including the average
balance of the entire mixed-use mortgage, figured under one of the
methods described earlier in this section.
Example 1.
In 1986, Sharon took out a $1,400,000 mortgage to buy her main home
(grandfathered debt). On March 2, 2001, when the home had a fair
market value of $1,700,000 and she owed $1,100,000 on the mortgage,
Sharon took out a second mortgage for $200,000. She used $180,000 of
the proceeds to make substantial improvements to her home (home
acquisition debt) and the remaining $20,000 to buy a car (home equity
debt). Under the loan agreement, Sharon must make principal payments
of $1,000 at the end of each month. During 2001, her principal
payments on the second mortgage totaled $10,000.
To complete line 2 of Table 1, Sharon must figure a
separate average balance for the part of her second mortgage that is
home acquisition debt. The January and February balances were zero.
The March through December balances were all $180,000, because none of
her principal payments are applied to the home acquisition debt. (They
are all applied to the home equity debt, reducing it to $10,000
[$20,000 - $10,000].) The monthly balances of the home
acquisition debt total $1,800,000 ($180,000 × 10). Therefore,
the average balance of the home acquisition debt for 2001 was $150,000
($1,800,000 × 12).
Example 2.
The facts are the same as in Example 1. In 2002,
Sharon's January through October principal payments on her second
mortgage are applied to the home equity debt, reducing it to zero. The
balance of the home acquisition debt remains $180,000 for each of
those months. Because her November and December principal payments are
applied to the home acquisition debt, the November balance is $179,000
($180,000 - $1,000) and the December balance is $178,000
($180,000 - $2,000). The monthly balances total $2,157,000
[($180,000 × 10) + $179,000 + $178,000]. Therefore, the average
balance of the home acquisition debt for 2002 is $179,750 ($2,157,000
× 12).
Line 1
Figure the average balance for the current year of each mortgage
you had on all qualified homes on October 13, 1987 (grandfathered
debt). Add the results together and enter the total on line 1. Include
the average balance for the current year for any grandfathered debt
part of a mixed-use mortgage.
Line 2
Figure the average balance for the current year of each mortgage
you took out on all qualified homes after October 13, 1987, to buy,
build, or substantially improve the home (home acquisition debt). Add
the results together and enter the total on line 2. Include the
average balance for the current year for any home acquisition debt
part of a mixed-use mortgage.
Line 7
The amount on line 7 cannot be more than the smaller of:
- $100,000 ($50,000 if married filing separately), or
- The total of each home's fair market value (FMV) reduced
(but not below zero) by the amount of its home acquisition debt and
grandfathered debt. Determine the FMV and the outstanding home
acquisition and grandfathered debt for each home on the date that the
last debt was secured by the home.
See Home equity debt limit under Home Equity Debt,
earlier, for more information about fair market value.
Line 9
Figure the average balance for the current year of each outstanding
home mortgage. Add the average balances together and enter the total
on line 9. See Average Mortgage Balance, earlier.
Note. When figuring the average balance of a mixed-use
mortgage, for line 9 determine the average balance of the entire
mortgage.
Line 10
If you make payments to a financial institution, or to a person
whose business is making loans, you should get Form 1098 or a similar
statement from the lender. This form will show the amount of interest
to enter on line 10. Also include on this line any other interest
payments made on debts secured by a qualified home for which you did
not receive a Form 1098. Do not include points on this line.
Claiming your deductible points.
Figure your deductible points as follows.
- Figure your deductible points for the current year using the
rules explained under Points in Part I.
- Multiply the amount in item (1) by the decimal amount on
line 11. Enter the result on Schedule A (Form 1040), line 10 or 12,
whichever applies. This amount is fully deductible.
- Subtract the result in item (2) from the amount in item (1).
This amount is not deductible as home mortgage interest. However, if
you used any of the loan proceeds for business or investment
activities, see the instructions for line 13, next.
Line 13
You cannot deduct the amount of interest on line 13 as
home mortgage interest. If you did not use any of the proceeds of any
mortgage included on line 9 of the worksheet for business, investment,
or other deductible activities, then all the interest on line 13 is
personal interest. Personal interest is not deductible.
If you did use all or part of any mortgage proceeds for business,
investment, or other deductible activities, the part of the interest
on line 13 that is allocable to those activities may be deducted as
business, investment, or other deductible expense, subject to any
limits that apply. Table 2 shows where to deduct that
interest. See Allocation of Interest in chapter 5 of
Publication 535
for an explanation of how to determine the use of loan
proceeds.
The following two rules describe how to allocate the interest on
line 13 to a business or investment activity.
- If you used all of the proceeds of the mortgages on line 9
for one activity, then all the interest on line 13 is allocated to
that activity. In this case, deduct the interest on the form or
schedule to which it applies.
- If you used the proceeds of the mortgages on line 9 for more
than one activity, then you can allocate the interest on line 13 among
the activities in any manner you select (up to the total amount of
interest otherwise allocable to each activity, explained next).
You figure the "total amount of interest otherwise allocable to
each activity" by multiplying the amount on line 10 by the
following fraction.
Example.
Don had two mortgages (A and B) on his main home during the entire
year. Mortgage A had an average balance of $90,000, and mortgage B had
an average balance of $110,000.
Don determines that the proceeds of mortgage A are allocable to
personal expenses for the entire year. The proceeds of mortgage B are
allocable to his business for the entire year. Don paid $14,000 of
interest on mortgage A and $16,000 of interest on mortgage B. He
figures the amount of home mortgage interest he can deduct by using
Table 1. Since both mortgages are home equity debt, Don
determines that $15,000 of the interest can be deducted as home
mortgage interest.
The interest Don can allocate to his business is the smaller
of:
- The amount on line 13 of the Table 1 worksheet
($15,000), or
- The total amount of interest allocable to the business
($16,500), figured by multiplying the amount on line 10 (the $30,000
total interest paid) by the following fraction.
Because $15,000 is the smaller of items (1) and (2), that is the
amount of interest Don can allocate to his business. He deducts this
amount on his Schedule C (Form 1040).
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