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Investors DON"T GET CAUGHT IN AN "ALL CASH PURCHASE" SNAFU WITHOUT KNOWING ABOUT IRS CODE SECTION 962!!  Trying to finesse the win in today's market frenzy to acquire real property bidding wars?

Did You Know that Congress Amended the Mortgage Interest Deductibility Rules to Require Anyone Paying all cash to purchase a Property put Financing in place within 90 days of the close of escrow or permanently lose their opportunity to write off the interest of future financing?  The only exception to that rule is given to Equity Loans taken out which are to cover the expense for documentable Home Improvement to the Property and there are rules you will find in I.R.S. Publication 962.  Excerpts from that code are shared below.

Home Mortgage Interest Deductibility Excerpted From I.R.S. Publication 936 (2012) 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 not used to buy, build, or substantially improve a qualified home 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 below.)
  • 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 below.)

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.
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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.  

Please click here for the text description of the image.

Figure C. John's example

Date of the mortgage.    The date you take out your mortgage is the day the loan proceeds are disbursed. 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 underQualified 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 $50,000 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 2000. 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 underAverage 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 1986. The mortgage was a five-year balloon note and the entire balance on the note was due in 1991. Chester refinanced the debt in 1991 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 Average Mortgage Balance in the Table 1 Instructionsthat follow.

Table 1 Instructions Unless you are subject to the overall limit on itemized deductions, 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.

In either of those cases, you do not need Table 1. Otherwise, you can 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 To Figure Your Qualified Loan Limit And Deductible Home Mortgage Interest For The Current Year
See The Table 1 Instructions. Part I Qualified Loan Limit

1. Enter the average balance of all your grandfathered debt. See line 1 instructions

2. Enter the average balance of all your home acquisition debt. See line 2 instructions

3. Enter $1,000,000 ($500,000 if married filing separately)

4. Enter the larger of the amount on line 1 or the amount on line 3

5. Add the amounts on lines 1 and 2. Enter the total here

6. Enter the smaller of the amount on line 4 or the amount on line 5

7. If you have home equity debt, enter the smaller of $100,000 ($50,000 if married filing separately) or your limited amount. See the line 7 instructions for the limit which may apply to you.

8. Add the amounts on lines 6 and 7. Enter the total. This is your qualified loan limit.

Part II Deductible Home Mortgage Interest

9. Enter the total of the average balances of all mortgages on all qualified homes. 
See line 9 instructions
  • If line 8 is less than line 9, go on to line 10.
  • If line 8 is equal to or more than line 9, stop here. All of your interest on all the mortgages included on line 9 is deductible as home mortgage interest on Schedule A (Form 1040).

10. Enter the total amount of interest that you paid. See line 10 instructions

11. Divide the amount on line 8 by the amount on line 9. Enter the result as a decimal amount (rounded to three places)

12. Multiply the amount on line 10 by the decimal amount on line 11. Enter the result. This is your deductible home mortgage interest. Enter this amount on Schedule A (Form 1040)

13. Subtract the amount on line 12 from the amount on line 10. Enter the result. This is not home mortgage interest. See line 13 instructions

13. 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.

SEE the Ask.com article on 1031 Exchanges under "MISCELLANEOUS" for mORE IMPORTANT INVESTMENT STRATEGIES"