Morre & Company, LLP
Certified Public Accountants
Six Hamilton Landing, Suite 220
Novato, California 94949
415-382-5600 Fax: 415-382-5605
May 2007
Dear Clients and Friends:
Email to Morre & Company
Spam is a problem with many consequences. One of those is that legitimate
emails are sometimes deleted with the spam. Whenever you send an email to
us, please include your name in the subject line. This is particularly important if
your email address is something like hotbunny@lol.com.
Home mortgage interest
The California Franchise Tax Board is taking an interest in interest deductions.
The agency believes that taxpayers are ignoring the limitation on home mortgage
interest. If they catch a taxpayer over-reporting mortgage interest deductions,
they will share their findings with the IRS.
Of course the rules are complicated. There are two sets of rules regarding the
deduction of interest. One set is the Home Mortgage Rules and the other is the
Interest Tracing Rules. It is easy to confuse and combine the rules when you
should not do so.
Home Mortgage Rules limit the deduction of interest to loans to buy, build or
improve your principal and second home up to $1,000,000. You can have an
additional $100,000 of qualifying mortgage as home equity debt, so the total
qualifying mortgage is $1,100,000. The $100,000 home equity debt is only
deductible for regular tax and is not for alternative minimum tax. These
mortgages must be secured by the residence.
If you have refinanced your home loan, you may have a portion of the principal
which is not used to buy, build or improve the residence. For instance; if you
refinanced your $600,000 mortgage for a new loan of $750,000, there is
$150,000 of new debt to account for. If at least $50,000 of that debt was used for
home improvements, then the balance will not be more than $100,000 (the home
equity loan interest) and all is fine (except possibly for alternative tax).
But watch out! The next year you refinance your $750,000 mortgage with a new
$800,000 mortgage and all of the extra proceeds pay off credit card and auto
loan balances. Now the total of the home equity debt may be more than
$100,000 and your mortgage interest deduction would be limited.
When congress first enacted these limitations in 1987, a $1,000,000 home loan
seemed generous. Twenty years later, inflation has made the limit easier to
reach and we see more clients exceeding that limit.
The other set of rules for deduction of interest are the Interest Tracing Rules.
Those rules require that you claim a deduction (or not) depending on the use of
the funds. So, if in that first refinance to a new loan of $750,000, you used the
$150,000 proceeds to buy:
1. Stock - then the interest is deductible investment interest, but the
deduction is limited to net investment income
2. Municipal bonds - then the interest is not deductible since the bonds are
not taxable
3. Rental property - the interest is deductible but limited by the passive loss
rules
4. A vacation residence or timeshare - not deductible under the tracing rules,
but may be a second home under the Home Mortgage rules
5. New car / vacation / your child’s education / medical expenses - not
deductible because these are personal expenses
6. A business - deductible without limitation unless the business is a passive
activity.
This is a lot to digest and difficult to apply. Before the next refinance or taking
out of a home equity loan, you should ask us whether the interest on your debt
will be deductible. To give you the answer, we will need to analyze all prior
refinancing on your residence. If you are a tax client, we keep copies of
refinance papers in your permanent file, so we may already have these.
We want to be green
Morre & Company is in the process of getting green certified! We are working on
ways to reduce paper use. If you have any suggestions, we would love to hear
from you.
Social Security Tax (FICA Tax) inflation
When the Social Security program started in 1937 the tax was 1% of the first
$3,000 of wages. It is rumored to be 7.65% of the first $102,600 of wages in
2008 (the wage limit was $97,500 in 2007). That is an increase from $30 to
$7,849 or 8% per year on average.
Final thought
This newsletter is for you. If there is a tax, planning or investing topic you would
like to learn more about, please let us know.
Please call us if you have any questions about this letter or any other tax,
financial or accounting issue.
