I think there is a misunderstanding here, note the introductory statement.
A mortgage secured by a qualified home may be treated as home acquisition debt,** even if you don't actually use the proceeds to buy, build, or substantially improve the home**. This applies in the following situations.
Here the taxpayer IS using the proceeds to substantially improve the home, so I don't think any of the three conditions below apply. I think that, since the taxpayer IS using the proceeds to improve the home, this other statement applies,
Home under construction.
You can treat a home under construction as a qualified home for a period of up to 24 months, but only if it becomes your qualified home at the time it is ready for occupancy.
The 24-month period can start any time on or after the day construction begins.
Alternatively, this paragraph supports your first answer.
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 isn't home acquisition debt.**
That would mean that the debt not yet paid to the contractor is equity debt for now, but become acquisition debt as soon as paid to the contractor. The "beginning 24 months before the mortgage" rules don't apply because this loan is being used to remodel the home, just not all at once.
