Is interest on second home mortgages deductible?

August 10, 2011

From:  Michael
Date:  19 Jul 2010
Subject:  question on construction loan interest

Dear Mr. Gray,

Our CPA is telling us that the interest for a second home we are having built is not deductible should we decide to rent the house during the summer season. Our bank will write a 30-year mortgage at the end of the construction period and the mortgage is designated as for a second home.

We also have another "second" home and a primary residence. The total of our mortgages with our primary home does not exceed one million dollars.

Will our residential interest deductions be limited?

Looking forward to your reply, sincerely.
Michael

Answer

Date:  14 Aug 2010

Hello Michael,

Yes. In general, you can only claim the residential interest deduction for your principal residence and one other residence. (IRC Section 163(h)(4)(A).) So, even if the mortgages for three properties total less than $1 million, you may only claim the interest deduction for two.

If the residence is rented out for too many days, it doesn't qualify for the residential interest deduction. In order to qualify as a residence, the second home must be used for personal purposes for the greater of (1) 14 days or (2) 10% of the number of days during the year for which the unit is rented at a fair rental. (IRC Sections 163(h)(4)(A), and 280A(d)(1).

If the home is used too many days for rental, the income and deductions, including interest expense, may be reportable on Schedule E as rental income or loss, subject to the passive activity loss limitations.

A residence under construction may be treated as a qualified residence for a period up to 24 months if the residence becomes a qualified residence when it is ready for occupancy. (Temporary Regulations Section 1.163-10T(p)(5)(i).

Good luck!
Mike Gray

We have more answers to frequently asked real estate tax questions! We also offer up-to-date information about new tax real estate tax developments in Michael Gray, CPA's Real Estate Tax Letter.

IRS Circular 230 Disclosure: As required by U.S. Treasury Regulations, you are hereby advised that any written tax advice contained on this website was not written or intended to be used (and cannot be used) by any taxpayer for the purpose of avoiding penalties that may be imposed under the U.S. Internal Revenue Code.