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Deductions & credits
For 2022, you can use the simplified method to determine the amount of qualified mortgage interest you paid. You were determined the total amount and acquisition debt amount as of January 1 and December 31 and then average to get the deductible amount of interest. For example, suppose you borrowed $200,000, of which $50,000 was acquisition debt. On January 1, 75% of your interest as qualified.You were determined the total amount and acquisition debt amount as of January 1 and December 31 and then average to get the deductible amount of interest.
For example, suppose you borrowed $200,000, of which $150,000 was acquisition debt. On January 1, 75% of your interest was qualified. During 2022 you paid $30,000 for improvements. As of December 31, your total loan balance was $198,000 (because you paid some against the principle) and your acquisition debt was $180,000, making 91% of your interest qualified. Averaged together, you can deduct 83% of your mortgage interest for the year.
As far as the two-year rule, I did not find it in black-and-white in publication 936, but the situation is murky. The tax law only says that interest on qualified acquisition debt may be deducted, and that qualified acquisition debt includes debt he used to buy, build, or substantially improve the home.
The IRS creates regulations that expand upon the law and explain how the law is to be followed, but if the regulations disagree with the law, the law must prevail. I could not find the specific regulation for this situation, but I may not have looked long enough.
Then the IRS creates publications that explain the regulations in simple language. There are several cases where the publication ignores or over simplifies certain aspects of the tax law, and some things that are allowed by the law or not included in the publications. Publication 936 has a statement under the heading of “debt that may qualify later“ which says that if you take a loan out before making the renovations, you can only count as qualified acquisition debt, reservations made in the two years before the loan. That makes absolutely no sense to me, and it ignores the plain language of the law, which says that acquisition debt includes the cost of renovations. The language in the publication is a misinterpretation or simple mistake. Even if not, it contradicts the law in an important common sense way— how can you pay for a renovation without taking out the loan first, but the loan doesn’t qualify if you take it out first. that just feels a commonsense test and I don’t believe that a court would hold it was a valid interpretation of the plain language of the law.
There is a separate provision that if you borrow money to construct your house, it can count as your residence for the interest deduction as long as you finish the house within two years.
Putting all that together, I think it is reasonable to conclude that if you borrow money to pay for a renovation, you can count those renovations as qualified acquisition costs as long as you complete them with a reasonable time after taking out the loan. And since two years is used in other cases covered by the law, it seems reasonable to use it here too.