Interest paid on "Acquisition Debt" on primary residence is tax deductible. Includes debt to acquire the home and also debt which is directly used to IMPROVE the home. EXCLUDES all other uses of debt taken out on home. Let's move past that, please. My concern is how TT is calculating this.
Round number example: $300,000 Mortgage at 10% interest, 30yr note to acquire home. Dated 1/1/20xx. Fine. All interest deductible (it will be $29,925 that first year, cents rounded off).
Let's say the very second after the mortgage is taken out, you refinance, also at 10% interest, 30yr, to 400,000 total. But the additional $100,000 you DO NOT use to improve the house. Total 1st year interest is now $39,900, but not all of it is deductible. You may notice that 75% of the refinanced 400,000 equals the original 300,000 and 7% of the $39,900 interest equals the original $29,925 interest.
Question: As the homeowner slowly pays off the principal, MUST the assumption be that homeowner pays off both the acquisition debt and the non-acquisition debt, ratably? In other words, for every $4 of principal paid down, MUST it be the case that $3 reduces acquisition debt and $1 reduces non-acquisition debt on the mortgage?
It would be to the homeowner's benefit, on taxes, to preferentially pay down the non-acquisition debt to zero before paying a dime toward acquisition debt. There's no tax benefit to the nonacquisition debt but there is to the acquistion debt. This distinction is irrelevant to the bank (just wants its full payment every month) and it's irrelevant to the monthly pocketbook of the home owner - the mortgage payment is the mortgage payment, however you like to think about slicing and dicing it. UNTIL tax time. Homeowner would want to pay off that debt with no tax benefit first before the debt that provides a tax benefit.
At the end of year 10, the mortgage balance on the $400,000 refi is $363,752. Period. The bank, the homeowner all agree. BUT, for taxes, the homeowner would prefer that the full 300,000 of "acquisition debt" remain on the books while the non-acquistion debt has been amortized from 100,000 down to only 63,752.
In so doing, the homeowner can continue to deduct the interest each year paid on the full 300,000 of acquisition debt (just like if it were an interest only loan where the principal is not amortized). Eventually, of course, homeowner pays off more than 100,000 of the mortgage and further principal amortization must be to the acquition debt.
So, Question 1: MAY the taxpayer designate which "pot" of principal is being amortized?
Question 2: How does TT calculate this - does it presume RATABLE principal payment allocation between acquisition and non-acquisition debt? If so, why?
