If you have a mortgage on your home, you likely know that you can deduct the interest paid to reduce your taxable income. However, the IRS places specific limits on the amount of mortgage debt eligible for this interest deduction, known as Acquisition Indebtedness Limits. Understanding these limits is crucial to accurately claiming your home mortgage interest deduction and optimizing your tax benefits.
What Are Acquisition Indebtedness Limits?
Acquisition Indebtedness Limits refer to the maximum amount of mortgage debt on a qualified residence that the IRS allows when calculating deductible mortgage interest. This limit applies to loans used to purchase, build, or substantially improve your home, including both primary and secondary residences.
Historical Context: Changes from the Tax Cuts and Jobs Act (TCJA)
Before 2018, the cap on Acquisition Indebtedness was $1 million per tax return ($500,000 if married filing separately). The Tax Cuts and Jobs Act (TCJA), effective from December 15, 2017, lowered this cap to $750,000 for new mortgages, or $375,000 if married filing separately, for acquisition debt incurred after that date. Mortgages taken out before December 15, 2017, are grandfathered under the previous $1 million limit, ensuring those homeowners retain the original deduction benefits.
How the Limits Work
- The IRS allows mortgage interest deductions only on debt within the Acquisition Indebtedness Limit.
- For mortgages after December 15, 2017, you can deduct interest on up to $750,000 of acquisition debt ($375,000 if married filing separately).
- For mortgages existing before that date, the limit remains $1 million ($500,000 if married filing separately).
- Interest on mortgage amounts exceeding these limits is not deductible.
- Home equity loans and lines of credit (HELOCs) only qualify as acquisition indebtedness if the loan proceeds were used to substantially improve the home.
Practical Examples
- Home Purchased Before 2018: If you took a mortgage of $950,000 in 2016, you can deduct interest on the full amount since it is below the $1 million grandfathered limit.
- Home Bought After 2017: A mortgage of $800,000 taken in 2019 would allow interest deduction only on $750,000; interest on the remaining $50,000 is nondeductible.
- Home Improvement Loan: If you borrowed $100,000 in 2020 for a significant home renovation, this amount counts toward your acquisition indebtedness limit, increasing the total mortgage debt subject to deduction.
Who Does This Affect?
- Homeowners with mortgages taken out after December 15, 2017.
- Those refinancing older loans must be cautious to avoid exceeding previous loan amounts; otherwise, they lose grandfathered limits.
- Borrowers using home equity loans must ensure funds are used for qualified home improvements to qualify for interest deduction.
Common Misconceptions
- Not all mortgage interest is deductible; only interest on acquisition indebtedness within the IRS limits qualifies.
- Refinancing doesn’t automatically reset limits; it only affects limits if the new loan exceeds prior mortgage balances.
- Since 2018, interest on home equity loans is only deductible when proceeds are used for substantial home improvements.
Acquisition Indebtedness Limits Summary Table
| Mortgage Date | Maximum Deductible Debt | Married Filing Separately Limit | Notes |
|---|---|---|---|
| Before Dec 15, 2017 | $1,000,000 | $500,000 | Grandfathered; older rules still apply |
| After Dec 15, 2017 | $750,000 | $375,000 | Applies to new mortgages and refinances |
| Home Equity Loans | Only if for home improvement | N/A | Deductible only if used for substantial improvements |
Frequently Asked Questions
Does Acquisition Indebtedness apply to second homes? Yes, these limits apply to both your main residence and qualified second homes.
What if my mortgage exceeds the limit? You can only deduct interest on the amount up to the IRS Acquisition Indebtedness limit. Interest on the excess is nondeductible.
Are the rules the same for rental properties? No, Acquisition Indebtedness rules apply only to personal residences. Rental property financing follows different tax rules.
Tax Planning Tips
- Keep detailed records of your mortgage origination date and loan use.
- When refinancing, avoid increasing your loan balance beyond the original mortgage if you want to keep grandfathered limits.
- Use home equity funds strictly for qualified home improvements to maintain eligibility for interest deduction.
For official information, refer to IRS Publication 936, which explains mortgage interest deductions including acquisition indebtedness.
Understanding these limits ensures you maximize your tax benefits without misfiling deductions. Consult a tax professional for personalized advice tailored to your mortgage situation.