A lot of people think that mortgage interest is always tax deductible, but that isn’t true.
In order to be tax deductible, the mortgage interest has to be attached to a “qualified residence,” which usually refers to one of two types of homes — a primary residence or a vacation home.
And the amount of deductible interest depends on whether the mortgage is classified as “acquisition indebtedness” or “home equity indebtedness.”
The “acquisition indebtedness” classification applies to mortgages used to buy, renovate or construct a qualified residence, and the “home equity indebtedness” classification applies to everything else. Usually, acquisition indebtedness mortgages allow you to deduct the interest on mortgage balances up to $1 million, whereas home equity indebtedness mortgages allow deductions on balances up to $100,000.
Another consideration is whether or not you’re subject to the Alternative Minimum Tax (AMT). If you are subject to the AMT, then you cannot deduct the interest on home equity indebtedness mortgages.
Obviously, there are significant advantages in structuring your mortgage so it can be classified as acquisition indebtedness.
For example, if you’re going to buy a vacation home, you’re better off placing a separate mortgage on that home and classifying it as acquisition indebtedness. It’s illegal to take cash out of your primary residence, and then deduct interest on the cash-out mortgage.
Please keep in mind that this is strictly for informational purposes. You should speak to an appropriate professional before making a financial, tax or legal decision.