Limits on the amount you can deduct as home mortgage interest refer back to the three categories previously defined under “Mortgages that Qualify”, in order to determine what is referred to as a “Qualified Loan Limit” in the IRS provisions. These three categories, for purposes of determining the limit, are:
Grandfathered debt
Home acquisition debt
Home equity debt
In effect, the limits for the three different categories depend on each other, in cases where all three are present.
Grandfathered Debt
Grandfathered debt refers to mortgages taken out on or before October 13, 1987. Interest on these mortgages is fully deductible without limit, but the loan amount reduces the $1 million limit for home acquisition debt (mortgages taken out after that date) and the limit based on your home’s fair market value for purposes of the home equity debt limit, as indicated below.
If you refinance grandfathered debt after October 13, 1987, the refinancing mortgage is still considered grandfathered debt provided the new loan is not more than the balance outstanding on the old loan. If the new loan is for a greater amount, the difference can be considered home acquisition debt or home equity debt.
Home Acquisition Debt
These are mortgages you took out after October 13, 1987 to buy, build, or substantially improve a qualified home (your main home or a second home). The debt that qualifies as home acquisition debt is limited to the cost of the home plus any substantial improvements. And, the average outstanding balance on home acquisition debt is limited to $1 million ($500,000 if married filing separately), reduced by any grandfathered debt. But loan amounts over these limits may qualify as home equity debt.
A mortgage can qualify as home acquisition debt even if it is not actually used to buy or build a home, or substantially improve a home at the time you take out the mortgage. You can buy your home within 90 days before or after you take out the mortgage loan. Or, if you build or improve your home and take out the mortgage before the work is finished, the mortgage will be treated as qualifying home acquisition debt up to the amount of your expenses. And, if you build or improve your home and take out the mortgage within 90 days after the work is completed, the loan will still qualify as home acquisition debt up to the amount of expenses you incurred during the 24-month period before the work is completed.
A loan to refinance home acquisition debt will still qualify as home acquisition debt for purposes of the limits, up to the balance of the old mortgage just before refinancing.
Home Equity Debt
These are loans you take out that are secured by your home (main home or second home), but do not qualify as home acquisition debt. For example, you may take out a home equity loan to pay for college. And, home equity debt, for these purposes, can include the amount by which home acquisition debt exceeds the limit.
The limit for home equity debt is the lesser of either $100,000 ($50,000 if married filing separately), or the excess of the fair market value of the home over the total of grandfathered debt and home acquisition debt.