Maximizing Home Mortgage Interest

By Sandy Botkin CPA, Esq.

"Compound interest: It is the greatest mathematical discovery of all time"

Albert Einstein


What this article will cover:

·                    When can we deduct home mortgage interest?

·                    What is a qualified home?

·                    When can we deduct home equity debt?

·                    How is hybrid debt treated?

·                    What is the limit to deducting interest on home acquisition debt?

·                    How do we get around the home acquisition debt limit?

·                    What are the tax consequences of Graduated Payment Mortgages?


Home mortgage interest: For most Americans, their home is their single biggest portion of their net worth. Many Americans believe that you can deduct any interest, especially interest incurred on your home. This myth is partially true.


General Rule for home mortgage interest: You may deduct interest paid on the acquisition debt and home equity debt secured by a qualified home. A qualified home can be either your principal residence or a second home. You must be the person liable on the debt and the debt must be used to either purchase or improve a qualified home.


What is a qualified home? A qualified home means:

·                    Your principal home, which is the home that you live in for most of the year, and

·                    One second home selected by you for purposes of deducting home mortgage interest.

·                    A home can be a house, condominium, coop, motor home, house trailer, or boat as long as these provide basic living accommodations such as a sleeping place, a toilet, and cooking facilities.


Sandy’s elaboration: Notice you can deduct interest on your primary residence and on one second home. You can choose from year to year, which second home would qualify. Thus, if you own several second homes, you can pick the one each year that gives you the biggest deduction.


Acquisition debt: Since interest in acquisition debt is deductible, what is acquisition debt? I am glad you asked. Acquisition debt is both:


·                    Incurred to purchase, construct, or substantially improve any qualified home and,

·                    Secured by that home. Thus, you acquisition debt is not debt incurred on your primary home that you use to buy another property such as your second home. It would be acquisition debt if it were secured by your principal residence to purchase or improve your principal residence.

·                    You must reduce your acquisition debt by any principal payments. You can increase your acquisition debt by borrowing money on your home equity to make improvements to your home.

Example: Charles buys a home for $400,000, incurring $300,000 of debt. This $300,000 constitutes acquisition debt. If he pays off$20,000 of principal over the next two years, his acquisition debt is now $280,000. Thus, if he refinances his home for $400,000, he can deduct interest as acquisition debt on the remaining balance of the original debt, which is $280,000


Home equity debt: In addition to being able to deduct your interest on acquisition debt, you can also deduct interest on your home equity debt up to $100,000 of debt. This debt can be used for anything such as college education for kids or even gambling. There is no limit on what a home equity debt can be used for.


Limitation on acquisition debt: Sadly, what Congress giveth, they taketh away. There is an overall limit on acquisition debt of $1,000,000 for married filing jointly or for single taxpayers and $500,000 for married filing separately)


B.I.S.T Strategy (Botkin Interest Shifting Technique): There is an old saying in Washington DC: “Where there is a will…..there’s a lawyer.” You can get around the $1,000,000 limitation for interest on acquisition debt by doing the following:


  1. Pay enough cash down so that your total acquisition debt doesn’t exceed $1,000,000, plus another $100,000 for home equity debt. Thus, your total debt should be limited to $1.1 million. This may involve liquidating some investments such as stock or bonds in order to raise the cash.
  2. Wait 91 days
  3. Refinance your home equity to take out much of the down payment that you made at closing.
  4. Buy back your stock and bonds with the refinanced money.


Result: You now can deduct not only the interest on the first $1.1 million as acquisition debt, but you can deduct all of the other interest incurred on the rest of the refinanced debt as investment interest.[1]Pretty neat, huh?


Graduated payment mortgages (GPM): There are a number of mortgage that allow for a lower payment that what a current amortization would require in order to allow buyers to afford housing. The difference in what would be needed to amortize the loan gets added to the mortgage balance. In future years, when the buyer’s income presumably rises, the mortgage payments increase to eventually amortize the whole mortgage.


Example: Mary buys a home taking out a loan for $500,000 at 6% interest. However, if her payments including taxes would have been $35,000, she might now be able to afford the payments. She, thus, takes out a Graduated Payment Mortgage where she pays only $25,000. The $10,000 difference gets added to the mortgage. In future years, her payments would increase as to eliminate the mortgage in 30 years.


Tax Effects of GPM: All payments made on a GPM while there are additions being made to the principal are deemed interest; thus, fully deductible if for acquisition debt. As payments are made to start reducing or amortizing the deferred interest, these payments would likewise be deemed interest and, thus, fully deductible. If the loan is refinanced with a different lending institution, the whole portion of the deferred interest will be deductible!



Sandy Botkin CPA, Attorney is the principal lecturer at the Tax Reduction Institute. He is a former trainer of IRS Attorneys. He is also the author of his bestselling books, “Lower Your Taxes: BIG TIME” and “Real Estate Tax Secrets of the Rich,” from which this article was derived.



[1] Investment interest is deductible to the extent of any investment income. Any excess of investment interest, gets carried over forever to be used against future investment income.