8032 / Is interest on debt secured by a taxpayer’s residence deductible?

Qualified residence interest is deductible, subject to certain definitions and limitations (see below and Q 8034). Qualified residence interest is interest paid or accrued during the taxable year on acquisition indebtedness or home equity indebtedness with respect to a qualified residence of the taxpayer.¹ Generally, it is deductible without regard to the expenditure to which it is allocated under the interest tracing rules. It is not considered in determining passive activity income or loss or the amount of investment interest.²

Interest paid by a taxpayer on a mortgage upon real estate of which the taxpayer is the legal or equitable owner may be deducted as interest on indebtedness, even though the taxpayer is not directly liable on the mortgage obligation.³ The Tax Court has held that a married couple was entitled to deduct amounts they paid on a construction loan taken by the builder as qualified residence interest although they were not personally obligated to repay the loan. The court concluded that the couple had a possessory and an equitable interest in the residence and could therefore deduct the applicable amounts.⁴ The Tax Court has also held that married taxpayers could deduct interest they paid on a mortgage as qualified residence interest, even though the taxpayer’s brother was the person directly liable on the mortgage obligation. The court found the taxpayers had held the benefits and burdens of ownership and thus were the equitable owners of the home and entitled to deduct qualified residence interest.⁵

The Tax Court denied a deduction for mortgage interest to individuals renting a home under a lease with an option to purchase the property; although the house was their principal residence, they did not have legal or equitable title to the home and the earnest money did not provide ownership status.⁶ Similarly, the Tax Court held that because a taxpayer had an option agreement and not an agreement for the purchase and sale of property, the taxpayer could not deduct mortgage interest or real property taxes. According to the court, the taxpayer had not acquired sufficient benefits and burdens relating to the property to be deemed the equitable owner of the property.⁷ An individual member of a homeowner’s association was denied a deduction for interest paid by the association on a common building because the member was not the party primarily responsible for repaying the loan and the member’s principal residence was not the specific security for the loan.⁸ Assuming that the loan is otherwise a bona fide debt secured by the principal residence, a taxpayer may deduct interest paid on a mortgage loan from a qualified plan even where the amount by which the loan exceeded the $50,000 limit of IRC Section 72(p) is deemed to be a taxable distribution.⁹

Definitions

Acquisition indebtedness: The definition of acquisition indebtedness has three parts: (1) the debt must be incurred to acquire, construct, or substantially improve a residence; (2) the residence must be a “qualified residence”; and (3) the debt must be secured by the residence.¹⁰ This definition is subject to the further definitions and limitations discussed below. Although all three parts must occur before the debt is acquisition indebtedness, they need not occur simultaneously. For example, a taxpayer may incur debt in 2024 to construct a residence and secure it by the residence. When the residence becomes a qualified residence in 2025, the debt would become acquisition indebtedness.

Home equity indebtedness: Home equity indebtedness means any indebtedness (1) that is secured by the qualified residence but is not acquisition indebtedness, (2) to the extent that it does not exceed the fair market value of the residence reduced by the amount of acquisition indebtedness. The aggregate amount that may be treated as home equity indebtedness (if incurred after October 13, 1987) is $100,000.¹¹ Limits with respect to debt incurred on or before October 13, 1987 are discussed below. Note that while the 2017 tax reform legislation suspended the deduction for interest on home equity debt, if the relevant debt would otherwise qualify as acquisition debt, interest on the debt may continue to be deductible so long as it does not exceed the cap for the year.

Incurred to acquire, construct, or substantially improve: There are two ways that the requirement that a debt be incurred to acquire, construct, or substantially improve a residence can be met. First, if the proceeds of a debt are used, within the meaning of the tracing rules found in Temporary Treasury Regulation Section 1.163-8T, to acquire, construct, or substantially improve the residence, the requirement is met. For example, a conventional, bank-financed consumer purchase of a principal residence will typically qualify under this provision because the loan proceeds will be traceable to the purchase of the residence. Alternatively, there is a 90-day rule (see below) under which debt may qualify. See Q 8043 for an explanation of the interest tracing rules. The limit on the amount of debt that may be treated as incurred to acquire, construct, or substantially improve a residence is the cost of the residence, including any improvements.

Qualified residence: A qualified residence is the taxpayer’s principal residence and one other residence that the taxpayer (a) used for personal purposes during the year for more than the greater of 14 days or 10 percent of the number of days it was rented at a fair rental value, or (b) did not rent during the year.¹² The IRS has ruled that where a principal residence is destroyed and the taxpayer sells the remaining land or reconstructs the dwelling and reoccupies it as the taxpayer’s principal residence within a reasonable time period, the property will continue to be treated as a qualified residence for the period between the destruction and the sale or reconstruction and reoccupation of the land.¹³

Secured by: Temporary regulations provide generally that an instrument of debt such as a mortgage, deed of trust or land contract will meet the “secured by” requirement, while a security interest such as a mechanic’s lien or judgment lien will not.¹⁴ If indebtedness used to purchase a residence is secured by property other than the residence, the interest incurred on it is not residential interest but is personal interest.¹⁵ Where a taxpayer uses an annuity contract as collateral to obtain or continue a mortgage loan, the allocable amount of interest is nondeductible to the extent the loan is collateralized by the annuity contract.¹⁶ However, where loans from IRC Section 401(a) qualified plans were secured by the debtors’ principal residences, the Service determined that the interest (which was otherwise deductible) was qualified residence interest.¹⁷

The Conference report for the Tax Reform Act of 1986 indicates that the security interest must be one perfected under local law.

In the case of housing cooperatives, debt secured by stock held by the taxpayer as a tenant-stockholder is treated as secured by the residence the taxpayer is entitled to occupy as a tenant-stockholder.¹⁸ Even though state or local law (or the cooperative agreement) may restrict the use of such stock as security, the stock may be treated as securing such debt if the taxpayer can satisfy the IRS that the debt was incurred to acquire the stock.¹⁹ Also, if state homestead laws or other debtor protection laws (in effect on August 16, 1986) restrict the rights of secured parties with respect to certain types of residential mortgages, interest on the debt is not treated as nondeductible personal interest, as long as the lender has a perfected security interest and the interest on the debt is otherwise qualified residence interest.²⁰

Tax Reform 

The 2017 tax reform legislation limited the mortgage interest deduction to interest on mortgages valued at $750,000 or less.
The 2025 OBBB makes the reduced exclusion permanent. The $750,000 limit applies to debt incurred after December 31, 2017.²¹ The 2025 OBBB also expanded the deduction so that mortgage insurance premiums will now be treated as interest. This limit applies to debt incurred after December 31, 2017 and before January 1, 2026.

Home equity indebtedness interest cannot be deducted for tax years beginning after December 31, 2017 (the 2025 OBBB made the TCJA change permanent).

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Planning Point: Although home equity indebtedness interest is technically no longer deductible under the terms of the 2017 tax reform legislation, the IRS released guidance on situations where home equity indebtedness may continue to be deducted. Pursuant to the guidance, interest on home equity loans that are used to buy, build or substantially improve the taxpayer’s home continue to be deductible to the extent that they (when combined with other relevant loans) do not exceed the $750,000 limit. However, home equity loan interest is not deductible to the extent that the loan proceeds are used for expenditures not related to buying, building or substantially improving a home (i.e., if the proceeds are used for personal living expenses or to purchase a new car, the related interest is not deductible). The home equity loan must be secured by the home for the interest to be deductible in any case.

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Example: In January 2026, Jerry takes out a $500,000 mortgage to purchase his primary residence. The loan is secured by the main home. In February 2025, Jerry takes out a $250,000 loan to purchase a vacation home. The loan is secured by 2026 vacation home. Because the total amount of both mortgages does not exceed $750,000, all the interest paid on both mortgages is deductible. However, if Jerry took out a $250,000 home equity loan on the primary residence to purchase the vacation home, the interest on the home equity loan would not be deductible.

The $750,000 limit does not apply with respect to debt incurred on or before December 15, 2017. If the taxpayer entered a binding contract on or before December 15, 2017 to close on the purchase of the taxpayer’s personal residence before January 1, 2018, and if the taxpayer actually purchases that residence before April 1, 2018, the debt will be treated as though it was incurred before December 15, 2017.²²

Debt amounts that are related to a refinancing will be treated as though incurred on the date that the original debt was incurred, provided that any additional amounts of debt incurred as a result of the refinancing do not exceed the amount of the refinanced debt. However, this exception does not apply if the refinancing occurs after the expiration of the term of the original debt. Further, it does not apply if the original debt was not amortized over its term, the expiration of the term of the first refinancing of the debt or, if earlier, the date which is 30 years after the date of the first refinancing.²³