Example. R's principal residence has an adjusted purchase price on December 31, 1988, of $105,000. R has two debts secured by the residence, with the following average balances and interest payments:
Debt | Date secured | Average balance | Interest |
Debt 1 | June 1983 | $80,000 | $8,000 |
Debt 2 | May 1987 | 40,000 | 4,800 |
Total | 120,000 | 12,800 |
The amount of qualified residence interest is determined under the simplified method by multiplying the total interest ($12,800) by a fraction (expressed as a decimal amount) equal to the adjusted purchase price ($105,000) of the residence divided by the combined average balances ($120,000). For 1988, this fraction is equal to 0.875 ($105,000/$120,000). Therefore, $11,200 ($12,800 * 0.875) of the total interest is qualified residence interest. The remaining $1,600 in interest ($12,800 - $11,200) is personal interest, even if (under the rules of § 1.163-8T ) such remaining interest would be allocated to some other category of interest.
For purposes of paragraph (e)(2)(ii) of this section, the average balance of a debt shall be treated as not exceeding the applicable debt limit of such debt. See paragraph (n)(1)(i) of this section for the rule that increases the adjusted purchase price in paragraph (e)(2)(i)(B) of this section by the amount of any qualified indebtedness (certain medical and educational debt). See paragraph (f) of this section for special rules relating to the determination of the fair market value of the qualified residence.
Debt | Date secured | Fair market value | Average balance | Interest |
Debt 1 | June 1983 | $100,000 | $80,000 | $8,000 |
Debt 2 | May 1987 | 140,000 | 40,000 | 4,800 |
Total | 120,000 | 12,800 |
the interest expense that is not qualified residence interest may be allocated among such expenditures, to the extent of such expenditures, in any manner selected by the taxpayer.
the average balance of the debt may be determined by adding the principal balance as of the first day of the taxable year that the debt is secured by the qualified residence and the principal balance as of the last day of the taxable year that the debt is secured by the qualified residence and dividing the sum by 2. If the debt is secured by a qualified residence for less than the entire period during the taxable year that the residence is a qualified residence, the average balance may be determined by multiplying the average balance determined under the preceding sentence by a fraction, the numerator of which is the number of days during the taxable year that the debt is secured by the qualified residence and the denominator of which is the number of days during the taxable year that the residence is a qualified residence. For purposes of this paragraph (h)(5)(i), the determination of whether payments are level shall disregard the fact that the amount of the payments may be adjusted from time to time to take into account changes in the applicable interest rate.
Balance on first day of the year: $9,652
Balance on last day of the year: $9,450
1987 | $120 = $20 * 6 months; |
1988 | $240 = $20 * 12 months; |
1989 | $120 = $20 * 6 months. |
Total | $480 |
All of the interest paid on the debt, including the allocable points, is qualified residence interest. Upon repaying the debt, the remaining $1,920 ($2,400-$480) in unamortized points is treated as interest paid in 1990 and, because the average balance of the secured debt in 1990 is less than the adjusted purchase price, is also qualified residence interest.
For purposes of this paragraph (m)(2)(ii), a taxpayer shall not be considered to have borrowed any additional amount with respect to a debt merely because accrued interest is added to the principal balance of the debt, so long as such accrued interest is paid by the taxpayer no less often than quarterly.
the grandfathered amount of the replacement debt is the average balance of the replacement debt. For purposes of the preceding sentence, the fact that proceeds of a replacement debt are used to pay costs of obtaining the replacement debt (including points or other closing costs) shall be disregarded in determining whether the entire proceeds of the replacement debt have been used to refinance one or more original debts.
Average balance | $9,500 | |
Amount of debt used to pay for qualified medical expenses | $4,000 | |
Less payments of principal before 1988 | $0 | |
Net qualified expenses | $4,000 |
The amount of qualified indebtedness for 1988 is, therefore, $4,000 (lesser of $9,500 average balance or $4,000 net qualified expenses). This amount may be added to the adjusted purchase price of C's principal residence under paragraph (e)(2)(i)(B) of this section for purposes of computing the applicable debt limit for this debt and any other debt subsequently secured by the principal residence.
Average balance | $8,500 | |
Amount of debt used to pay for qualified medical expenses | $4,000 | |
Less payments of principal before 1988 | $1,000 | |
Net qualified expenses | $3,000 |
The amount of qualified indebtedness for 1989 is, therefore, $3,000 (lesser of $8,500 average balance or $3,000 net qualified expenses).
1988: $5,000
1989: $10,000
1990: $15,000
1991: $20,000
A debt will not be considered to be secured by a qualified residence if it is secured solely by virtue of a lien upon the general assets of the taxpayer or by a security interest, such as a mechanic's lien or judgment lien, that attaches to the property without the consent of the debtor.
A taxpayer cannot have more than one second residence at any time.
26 C.F.R. §1.163-10T