Tax Planning for Medical Practitioners: Taking Advantage of the Home Mortgage Interest Deduction
The home mortgage interest deduction is one of the most common and popular deductions, particularly for physicians who may own large homes and those with larger mortgages. It is also one of the few deductions retained in President Trump’s tax reform proposal announced in late April. There are various rules that must be adhered to in computing the mortgage interest deduction.
A homeowner can deduct mortgage interest paid on a loan secured by either their principal residence or one secondary residence (qualified home). The definition of a residence includes stock in a cooperative housing corporation owned by a tenant-stockholder, often referred to as a co-op apartment. A boat can qualify as a residence as long as it has both kitchen and sleeping facilities. If a taxpayer owns more than two residences, only one of the secondary residences can qualify for a home mortgage interest deduction even if the taxpayer has no mortgage on their principal residence. A deduction cannot be claimed when a loan is taken out on one residence, but the borrowed funds are used to purchase or construct a different residence.
The home mortgage interest deduction has two components – home acquisition debt and home equity debt. Home acquisition debt is a mortgage taken out after October 13, 1987 to buy, build, or substantially improve a qualified home. The total amount that can be treated as home acquisition debt is limited to $1 million. Home equity debt is a mortgage also taken out after October 13, 1987 that is used for reasons other than to buy, build, or substantially improve a qualified home. The total amount that can be treated as home equity debt is limited to $100,000. The aforementioned $1 million and $100,000 limitations apply to taxpayers filing as single, married joint, and as head of household. These limits are cut in half to $500,000 and $50,000, respectively, for taxpayers filing using a married separate status.
The significance of the October 13, 1987 date is that a mortgage taken out before October 14, 1987 is defined as “grandfathered” debt, which has no limitation. Any refinanced grandfathered debt after October 13, 1987, for an amount not greater than the mortgage principal remaining on the debt, will continue to be treated as grandfathered debt.
Another item to be aware of when it comes to computing the home mortgage interest deduction is the payment of “points”, often referred to as loan origination fees or loan discount fees. These are charges paid by a borrower to obtain a home mortgage. Points can be deducted in the year paid if a number of tests are met, including the loan being secured by the borrower’s principal residence; the points were computed as a percentage of the principal amount of the mortgage; and the amount is clearly shown on the settlement statement, such as Form HUD-1. Points paid on a secondary residence, or in connection with a refinancing, cannot be deducted in the year paid, but instead, are deductible ratably over the life of the loan.
The IRS closely scrutinizes the home mortgage interest deduction. Numerous desk audits are conducted where the IRS believes the deduction claimed may be excessive. Taxpayers are asked to provide copies of deeds, loan agreements, and statements documenting beginning and ending mortgage principal balances, so that the IRS can determine the accuracy of the calculated home mortgage interest deduction.
Various members of Congress have expressed their opinion in recent years that the home mortgage interest deduction should be scaled back. There has been talk of either reducing the mortgage balance thresholds, or of no longer allowing a deduction for home mortgage interest paid on a secondary residence. However, there have been no changes to the rules in this area since 1987. For further information on this subject, view IRS Publication 936.
What Does CohnReznick Think?
For medical practitioners who often find themselves with hefty loans, reducing your tax burden where possible is financially astute and can increase your ability to grow your wealth. Begin by taking advantage of the home mortgage interest deduction, which can provide substantial savings for physicians who carry a sizeable mortgage.
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