Congratulations on paying cash for your home! I just wanted to make you aware that the IRS gives you a 90 day window to put a mortgage on your property and gain the tax benefits associated with the coveted “acquisition indebtedness” status.
What is “Acquisition Indebtedness” and Why Does it Matter to Me?
Any mortgage that is used to buy, build, or improve a primary or vacation home qualifies for “acquisition indebtedness” status. Any mortgage that is used for any other purpose is demoted to the “home equity indebtedness” status.
If you don’t put a mortgage on your primary or vacation property within 90 days of the purchase closing date, any mortgage you put on the property in the future that is not used specifically for home improvements will be demoted to “home equity indebtedness” status. This means that:
- You will NOT be able to deduct ANY of the interest at all if you are subject to the Alternative Minimum Tax (AMT)
- You will only be able to deduct the interest on up to $100,000 of the mortgage balance if you are not subject to the AMT
On the other hand, if you do put a mortgage on your primary or vacation property within 90 days and qualify for the special “acquisition indebtedness” status:
- You can use the funds for any purpose you want (including investment, starting a college fund for the kids or grandkids, retirement needs, etc.)
- You can deduct the interest on up to $1,000,000 of mortgage balance regardless of whether you are subject to AMT
Is There a Deadline to Qualify for the Tax Benefit?
Yes! You must put a mortgage on your primary or vacation property within 90 days of the purchase closing date in order to qualify for the special “acquisition indebtedness” status.
What if I Wait Until After 90 Days?
You will lose the special tax benefits associated with the “acquisition indebtedness” status. Any mortgage you put on your primary or vacation property in the future that is not used specifically for home improvements will be classified as “home equity indebtedness”.
Okay, So I Lose the Tax Benefit… But Why Would I Want a Mortgage On My Property in the First Place?
With interest rates being so low right now, you could use the funds for any number of reasons including:
- Investment – can you and your financial advisor find a safe investment that yields more than the 2% or 3% after-tax cost of your mortgage?
- College fund for your children or grandchildren – would you rather leave them a bunch of equity in a home or a legacy that makes an impact in their life?
- Elder care needs – do you have enough set aside to care for yourself or your loved ones as you age?
- Retirement needs – do you have enough set aside to provide income during retirement?
- Vacation home or other property – how are you taking advantage of the clearance sale going on in the housing market right now?
Remember, if you decide to wait and use a mortgage to do any of these things in the future, you won’t be able to deduct the mortgage interest. It may be worthwhile to put a mortgage on the property now, and then put the funds aside until you know what you want to do with them. After you make a decision, you could then pay off or pay down the mortgage with any leftover funds that you don’t use.
Does the “90 Day Rule” Also Apply to Investment Properties?
No. Investment properties have different rules, deadlines and guidelines that must be followed.
What’s the Next Step?
I would recommend that we have a brief 20-30 minute conversation to evaluate your options and whether a mortgage might make sense for you right now. You could then take my recommendations to your CPA and get his or her opinion before making a decision. If you don’t have a CPA, I’d be happy to make an introduction for you. Contact me using the info below so we can get started!
PLEASE NOTE: THIS LETTER AND OVERVIEW IS PROVIDED FOR INFORMATIONAL PURPOSES ONLY AND DOES NOT CONSTITUTE LEGAL, TAX, OR FINANCIAL ADVICE. PLEASE CONSULT WITH A QUALIFIED TAX ADVISOR FOR SPECIFIC ADVICE PERTAINING TO YOUR SITUATION. FOR MORE INFORMATION ON ANY OF THESE ITEMS, PLEASE REFERENCE IRS PUBLICATION 936.