If the loan isn't for "acquisition," meaning for the purchase of the home, deductibility is limited to interest charges on loan amounts to $100,000 -- but deductibility is allowed on interest charges on debt in excess of $100,000 when the funds are used for home improvements, says Greg Rosica, partner with Ernst & Young, Tampa, Fla.
Making it even more confusing, the fair market value, or FMV, of your home also comes into play when figuring out allowable deductions.
The IRS offers this example in Publication 936: You own one home that you bought in 2000. Its FMV now is $110,000, and the current balance on your original mortgage is $95,000. Bank M offers you a home mortgage loan of 125 percent 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 percent x $110,000 equals $137,500, minus $95,000 gives you $42,500). But the interest is deductible only on $15,000 of that, because deductibility is limited to whichever is smaller: the $100,000 maximum limit or the amount the current FMV ($110,000) exceeds the amount of your original mortgage ($95,000).
If you are using funds for home improvements, keep receipts and other applicable records, adds Rosica.
Compare yourselfThe IRS won't provide any specifics as to when and how it will pursue audits, with spokesmen only saying that the agency has identified corrective actions to more effectively pursue potential nonfilers and under-reporters through mortgage data.
In his many years as a CPA, Lazor says he's never seen an audit triggered by the IRS looking for minor infractions of home equity deductibility. It's much more likely that the IRS will focus on finding nonfilers or finding individuals who grossly underreport their likely income, based upon what the 1098 shows.
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