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MY HOME EQUITY LOAN IS DEDUCTIBLE. ISN'T IT?

March 18, 2005

Home equity loans are very popular. They have lower interest rates than credit card debt. Their tax deductibility often clinches the deal. Unfortunately, for many taxpayers that deduction is a mirage.

A Revenue Ruling issued yesterday highlights the often-overlooked dark side of home equity loans: they are deductible for regular tax, but not for alternative minimum tax.

In Revenue Ruling 2005-11, a taxpayer borrowed $100,000 to purchase a home. Over time, and after one refinancing, he had paid the balance down to $80,000. He then refinanced the home again for $110,000, not using any of the refinance proceeds to improve the home.

In computing his deduction for regular tax purposes, the taxpayer can deduct his interest on the entire $110,000 balance. In computing the interest for AMT, however, he can only deduct interest on $80,000. At a 7% interest rate, that translates into a lost deduction of $2,100.

As we've discussed, AMT is becoming the default tax system for more and more taxpayers. This is especially true in states like Iowa with high state income taxes, which are not deductible for AMT. Almost any two-earner professional couple with children is a likely AMT candidate in Iowa.

The moral? Don't bank on a home equity loan deduction unless you know you are not paying AMT.

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