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Loan on Two Homes

2009-12-14 by Eva Rosenberg

Today TaxMama hears from Jon in California, who has this plan. “I am going to refinance my current residence for $338,000. I will use $140,000 of that to pay off the existing mortgage. The remainder will be a down payment on my next house. The next house will be my primary residence; the current house will then be a rental. My question is about the interest on the current house’s new mortgage. Is it all claimed on schedule E? Only the bit associated with the $140,000 payoff?”

Dear Jon,

That’s an interesting way to go about it.

OK, $140,000 will replace your current mortgage. So, yes, use the interest on 41.42% of the new loan as rental interest.

Since the rest will be applied to your new home, use 58.58% of the interest on that loan as your home mortgage.

Keep using this proportion until the loan is paid off – or until you make a large lump sum payment. Then, determine which loan you’re paying off – and update the percentages.

Incidentally, if you lived in your last home for at least 5 years, remember to take advantage of the new homebuyers credit, worth $6,500. http://www.irs.gov/newsroom/article/0,,id=204671,00.html

And remember, you can find answers to all kinds of questions about mortgage interest and other tax issues, free. Where? Where else? At TaxMama.com.

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# | Posted in Tax Quips | Comments » (5)

All Comments

mary taylor Says:
December 14th, 2009 at 12:04 pm

Please be advised when the client goes to apply for a mortgage loan the rental income on the home that is being converted into a rental might not be able to qualify for the mortgage on the new primary residence. The client has to have a certain amount of equity in the home that is being converted into a rental in order to be allowed to use the new rental income to quality.

Alison T. Jacks EA Says:
December 14th, 2009 at 11:02 pm

I don't believe this taxpayer can deduct 58.58% of his loan interest on Schedule A as home mortgage interest. Qualified home acquisition mortgage interest must be paid on a mortgage secured by such residence, i.e. the taxpayer's new home. Interest paid on a mortgage from the previous-residence-converted-to-rental does not qualify. This part of his interest would seem to be completely nondeductible, since it's not rental interest and not home mortgage interest.

Eva Rosenberg, Your TaxMama® Says:
December 15th, 2009 at 04:31 am

You're right, Alison. That's an interesting point. So, in order to deduct the interest, he needs to have a mortgage on the new home, owed to his rental property. Best way to do that is to put the rental into another entity, like an LLC.

The mortgage contract would be between the LLC and him. A little complicated at first, and it would add an extra $800 annual fee + tax prep fees – but it would let him deduct the mortgage interest. Sigh.

What a pain. But the letter of the law prevails!

Hugs,

Eva

Jon Says:
December 15th, 2009 at 01:45 pm

I liked your first response better Eva! Unfortunately, the answer Alison came up with is what I was thinking from reading the IRS information. Oh well. As to Mary, I checked into that, and I'm ok, I don't need the rental income to qualify for both loans.
Thanks to all.

David Toelkes Says:
December 24th, 2009 at 11:39 pm

There is an easier solution, Eva.

When Jon uses a portion of the loan proceeds on his soon to be rental property to purchase his new main home, that portion of the loan is still acquisition debt. It just does not qualify for the home mortgage interest deduction because the loan is not secured by the main home.

To fix this, Jon could refinace his new main home and convert the debt to acquisition debt secured by his main home and then regain entitlement to take the home mortgage interest deduction.