What is the calculation for the prorated mortgage interest deduction if the mortgage includes $20,000 in unqualified personal debt and the total home equity debt is $350,000?
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To determine the prorated mortgage interest deduction when a mortgage includes $20,000 in unqualified personal debt and the total home equity debt is $350,000, you must apply the limitations on deductible home mortgage interest under IRC §163(h) and related regulations. Here’s a step-by-step explanation of the calculation, incorporating the relevant legal details and methods:
1. Identify the Types of Debt and Their Limits
- Acquisition Debt: Debt incurred to buy, build, or substantially improve a qualified residence, secured by that residence.
- Home Equity Debt: For tax years before 2018 and after 2025, interest on home equity debt (not used to buy, build, or improve the home) may be deductible, subject to limits. For 2018–2025, only the portion used to buy, build, or improve the home is deductible.
- Personal Debt: Any portion of the mortgage not used for qualified purposes (e.g., to buy a car, pay personal expenses) is not deductible.
2. Determine the Qualified Loan Limit
For 2024 (and through 2025), the maximum amount of acquisition debt eligible for the interest deduction is $750,000 ($375,000 if married filing separately). For debt incurred before December 16, 2017, the limit is $1,000,000 ($500,000 if married filing separately).
3. Calculate the Average Balance of the Mortgage
You must determine the average balance of the mortgage for the year. This can be done using the average of the beginning and ending balances, the interest-paid-divided-by-interest-rate method, or monthly statements, as described in IRS Publication 936 and Treas. Reg. §1.163-10T(h).
4. Allocate the Debt
- Qualified Debt: The portion of the mortgage used to buy, build, or substantially improve the home, up to the applicable limit.
- Unqualified Debt: The $20,000 in personal debt is not acquisition or home equity debt used for qualified purposes, so interest on this portion is not deductible.
- Total Debt: $350,000 (home equity debt, but only the portion used for qualified purposes is deductible).
5. Prorate the Interest Deduction
If the mortgage includes both qualified and unqualified debt, you must prorate the interest deduction. The deductible portion is determined by the ratio of qualified debt to total debt.
Formula:
[\text{Deductible Interest} = \text{Total Interest Paid} \times \left(\frac{\text{Qualified Debt}}{\text{Total Debt}}\right)]
Example Calculation:
Suppose:- Total mortgage: $350,000- Unqualified personal debt: $20,000- Qualified debt: $350,000 - $20,000 = $330,000- Total interest paid during the year: $14,000
[\text{Deductible Interest} = \$14,000 \times \left(\frac{\$330,000}{\$350,000}\right) = \$14,000 \times 0.942857 = \$13,200]
So, $13,200 of the interest is deductible as home mortgage interest, and $800 is nondeductible personal interest.
6. Reporting
- Deductible interest is reported on Schedule A (Form 1040), line 8a or 8b.
- Nondeductible interest is not reported.
7. Legal Authority
- IRC §163(h)(3): Defines qualified residence interest and limits.
- Treas. Reg. §1.163-10T(e): Provides the method for prorating interest when the secured debt exceeds the qualified limit or includes unqualified debt.
- IRS Publication 936: Offers worksheets and examples for calculating the deductible portion.
- CCA 200911007: Confirms the use of a ratio to prorate deductible interest when the mortgage exceeds the qualified limit.
8. Special Note for 2025 and Beyond
For tax years after 2025, the deduction for home equity interest may be restored for debt not used to buy, build, or improve the home, subject to the $100,000 limit ($50,000 if married filing separately), but for 2024 and 2025, only the portion used for qualified purposes is deductible.
Summary: To calculate the prorated mortgage interest deduction when the mortgage includes $20,000 in unqualified personal debt and the total home equity debt is $350,000, multiply the total interest paid by the ratio of qualified debt ($330,000) to total debt ($350,000). The result is the deductible interest; the remainder is nondeductible personal interest.
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