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Lessons from the Tax Court: Build up mortgage interest deductions

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in Small Business Tax,Small Business Tax Deduction Strategies

Generally, you can deduct qualified mortgage interest during the 24 months your home is under construction. But suppose the home is never built? A new Tax Court case provides some insight.

Facts of the case: In 2006, a couple took out a $1.26 million loan to buy beachfront property in Florida. They demolished the existing home on the property and developed plans to build a new vacation home. But the project was delayed due to difficulty obtaining building permits and environmental factors.

When the permits were finally approved in 2008, the real estate market in Florida had plummeted and the couple could not obtain the financing needed to build the home. A year later, they sold the property for $725,000, incurring a loss of $825,000.

In 2007 and 2008, the couple claimed mortgage interest deductions of $87,016 and $82,201, respectively, for the Florida property. But the IRS denied the deductions. Reason: It said that there was no house “under construction,” so the taxpayers weren’t entitled to deduct any mortgage interest.

Bottom line: The Tax Court ruled in favor of the couple. The demolition and site clearing, trying to obtain the building permits and all the preparation work and planning were necessary components of the construction process. The court noted the regulations do not specifically address a situation where a residence under construction is never actually built. Because the couple still intended to build the home in 2007 and 2008, the deductions are allowed. (Rose, TC Summary Opinion 2011-117)

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