ROANOKE TIMES
Copyright (c) 1996, Roanoke Times
DATE: Monday, February 19, 1996 TAG: 9602200109
SECTION: THE MONEY PAGE PAGE: 6 EDITION: METRO
COLUMN: Tax Questions
Q: I bought about 150 acres of land through seller-financing. The seller allowed the down payment to secure about five acres of land free and clear. On that land I built a house which is mortgaged.
Of course the interest on the payments on the house is deductible because the mortgage is secured by my house.
Because the land payments are not secured by a residence (that is, the 145 acres), do I have any way of claiming a deduction on the interest paid on those payments? If not, what deductions would be possible for the land payments?
A: The answer to your question(s) is, unfortunately, like so many others regarding the application or interpretation of the Internal Revenue Code - not exactly black and white.
First, there is the question of what constitutes a "residence" for the purposes of the qualified home mortgage interest rules.
To be "qualified residence interest," the related indebtedness (acquisition or home equity) must be secured by any "qualified residence," generally the taxpayer's principal residence and/or a second home.
Note the word "residence," not "house." The definition of qualified residence, for purposes of the interest deduction, is found in the section of the Internal Revenue Code that deals with gain from the sale or exchange of a residence (IRC Sec. 1034). The definition basically says that the determination of whether property is used by the taxpayer as a residence is made by looking at all the facts and circumstances, including the good faith of the taxpayer.
The courts have consistently held that a qualified residence would include all real property, that is both the house and surrounding land, that is used as such. Where the principal residence has substantial acreage, the entire estate may constitute the "qualified residence" as long as all of it is used as a residence. If the surrounding acreage or a portion thereof is used for income-producing purposes, then an allocation of the interest is required.
In determining whether all or part of substantial surrounding acreage constitutes part of the taxpayer's qualified residence, the IRS may examine several factors including, but not limited to, the following:
1. Is the land appropriate for other uses?
2. How is the land classified for real estate tax purposes?
3. How are the land and home deeded? Together or separately?
4. Are zoning or other restrictions imposed by the local municipality?
5. And, most importantly, how did, does and will the taxpayer, in fact, use the surrounding land?
If your "facts and circumstances" support a claim that your house and all, or at least a significant portion (greater than five acres) of its surrounding 150 acres are being used as your residence, you might have a reasonable basis for treating interest on both loans as "qualified home mortgage interest," if the initial land purchase loan is secured by the 145 acres.
If, on the other hand, your "facts and circumstances" indicate that you did not have a good-faith intent to use the surrounding acreage as your residence, then the interest on the initial land purchase loan would not be deductible as "qualified home mortgage interest." The interest (on the initial loan) could be deductible as rental, farm or investment interest, depending on how, in fact, the land is used or held.
Of course, all real estate taxes relating to your property would be deductible regardless of what portion you claim as your part of your "qualified residence." If a portion of the land is rented and/or farmed, you will have to allocate the interest and real estate taxes to the separate activities and deduct them on Schedule E and/or Schedule F.
If you are holding some or all of the 145 acres for investment purposes, the allocated interest is deductible, subject to net investment income limitation, as investment interest.
One final note: Expenses that are deducted in arriving at adjusted gross income often yield greater tax savings than those deducted from adjusted gross income, that is itemized deductions.
-Answered by Mark F. Coles of H. Schwarz & Co.
LENGTH: Medium: 75 linesby CNB