HELOC Deduction Calculation

I'm trying to follow the instructions/worksheet in Pub 936, and I'm struggling to interpret the methodology. Client has a primary mortgage which was used 100% for acquisition indebtedness. Client also has a HELOC which had an approximate $100,000 balance at 01/01/18 - none of which was used for acquisition or home improvements. During the year, taxpayer draws $50,000 on the HELOC for home improvements.

My assumption that we would take 100% of the primary and then just make a calculation on the HELOC for the deductible portion doesn't seem to be accurate. Would anybody be willing to dumb this calculation down for me so that I can just make an Excel worksheet moving forward to input the data I need to determine the deductible portion?

What I would do is start with the interest shown on F1098. Subtract off the interest for those months prior to him making the home improvement, since that interest is ND. The remaining interest would represent what accrued on the $150k balance. Deduct 1/3rd of it.

Agree with Jeff.

" Would anybody be willing to dumb this calculation down for me so that I can just make an Excel worksheet moving forward to input the data I need to determine the deductible portion?"

Ignoring the instructions, as per previous advice, is not the same thing as dumbing them down.

wb923, doesn't your professional software have a mixed use mortgage deduction input screen? Since this has always been required (to determine if AMT tax was owed), it's not new, and something your tax software should have implemented long ago. UltraTax has one, and I've had to use it a few times, but it is a pain. In UT, each mortgage has its own input section so that the IRS instructions can be properly followed.

Ignoring the instructions

What important thing(s) do the instructions tell us that we should do?

When repaying the HELOC, would repayments be made first to personal ND balance, Acquisition balance, or ratably?

I believe that repayment goes first to clear the nonqualified debt. Once that is cleared, then you get the full amount of mortgage interest.

Here’s a bit longer calculation, but it accounts for different loan balances each month.

1. Determine the average loan balance of the HELOC loan for the year. Example:
$100K for first 5 months
$120K for 1 month
$130K for 1 month
$150K for last 5 months
Avg. loan balance = [($100K x 5) + 120K + $130K + ($150K x 5)] / 12 = $125K

2. Take the interest on Form 1098 and divide it by the average balance determined in #1.
Example: $7,500 interest / $125K = 6%

3. Take the average balance and subtract the non-acquisition debt balance.
Example: $125K - $100K = $25K

4. Multiply #2 by #3. This is the interest on the acquisition debt portion of the HELOC.
Example: 6% x $25K = $1,500.

I came across this in CCA 201201017:

Since enactment of OBRA 1987 the $1,000,000 acquisition indebtedness limitation and the $100,000 home equity indebtedness limitation must be substituted for the adjusted purchase price.

Ok, let’s do that. Here’s part of the -10T regulation, as written:

(c) Determination of qualified residence interest when secured debt does not exceed adjusted purchase price.
(1) In general. If the sum of the average balances for the taxable year of all secured debts on a qualified residence does not exceed the adjusted purchase price (determined as of the end of the taxable year) of the qualified residence, all of the interest paid or accrued during the taxable year with respect to the secured debts is qualified residence interest.

Here it is re-written, as the CCA tells us to do:

(c) Determination of qualified residence interest when secured debt does not exceed the $1m Acquisition Indebtedness limit
(1) In general. If the sum of the average balances for the taxable year of all secured debts on a qualified residence does not exceed the $1m Acquisition Indebtedness limit (determined as of the end of the taxable year) of the qualified residence, all of the interest paid or accrued during the taxable year with respect to the secured debts is qualified residence interest.

Hmmm…interesting result when we re-write the regulation. Here we have the OP with a mixed-use loan, whose balance is < $1m, but the re-written regulation tells us to deduct all of the interest…

That can’t be right. So what is the next step?

Jeff-Ohio, you're right that all of the interest is “qualified residence interest” because all of the interest was paid on acquisition indebtedness and home equity indebtedness (sec. 163(h)(3)(A)). But the problem is that for 2018-2025, sec. 163(h)(3)(F)(i)(I) disallows home equity indebtedness interest.

Jeff-Ohio, you're right that all of the interest is “qualified residence interest” because all of the interest was paid on acquisition indebtedness and home equity indebtedness (sec. 163(h)(3)(A)).

Yes, but how do we ascertain which piece is which…on this single, mixed-use debt?

So far, we’ve heard a variety of ideas…Post #2, Post #4 and Post #8. Which of these methods, plus, perhaps, other methods not yet identified, is the one forced upon us by the actual law?

So what do we require the taxpayer to provide to be able to perform these calcs. What about the client that took out heloc 8 years ago and the first draw was for windows and then a few years later another draw was for a car, and another few years later for a new furnace /ac. How do we determine the balance left on each if these? No one has statements that far back to verify amounts (memory is foggy at best) and the mortgage company has been sold twice since.

I echo Jeff’s question. If these things happened in the past few years, it’s worth figuring out but beyond that, who’s paying my fee to spend the kind of time this would take? A grandfather clause would have been nice.

Several years ago I represented a client in an IRS audit who had refinanced her home mortgage 15 times over a 20-year period, and she couldn’t remember (and had no records showing) what she spent the money on. I obtained building permits from the county and other real estate records, but ultimately, she lost $35K of her $75K home mortgage interest deduction in 2 tax years.

Taxpayers have the burden of proving that they used the proceeds of the loan to acquire, construct or substantially improve a qualified residence. They can use any method to do this as long as it's reasonable.

'Hijacking this thread.

If client had 20k HELOC balance at beginning of year, and 120k at end of year. Add them together and divide by 2, you get 70k avg balance. Would it be correct to deduct the entire amount of interest based on the average balance?

Or is part of the average ruled out, since the 100k limitation was exceeded?

Assume they are not over 750k limit. All proceeds were used for home improvements.

I have read over Pub 936, and Everything I can look at, and I don't see a clarification on this issue.

Noobie - no adjustment needed. If all money went into home then all is considered acquisition debt. Since under the 750k limit, all is deductible.

Thank you.