Home mortgage interest and investment interest both are deductible in computing the Regular Tax, although certain limitations apply. The Alternative Minimum Tax similarly allows these deductions, but they are subject to differences in the limitations. Understanding these differences will allow a taxpayer to plan in advance to minimize their AMT impact.

Home Mortgage Interest

In addition to the primary mortgage on a residence, allowable interest includes home equity loans and mortgages on a second home. For home equity loans not used to improve the residence, interest is deductible only to the extent the loan does not exceed $100,000.

Additional restrictions apply, however, before the interest is AMT-deductible. On home equity loans one must look to how the loan proceeds were used. If used to fix up or otherwise improve the primary residence, the interest is fully deductible for the AMT. If instead the money is used to buy a new car (a common way to get cheaper financing than a car loan), or other purpose not involving work on the residence, the interest is not deductible for the AMT. For example, assume $15,000 in interest on the first mortgage, and $2,000 of interest on the equity line of credit that was used to buy a new car. The total interest deduction for the Regular Tax is $17,000, yet for the AMT the deduction is limited to $15,000. That $2,000 is one of the items reported on the Form 6251.

For Regular Tax purposes, a second home that will qualify for the mortgage interest deduction includes certain mobile homes or boats, in addition to the traditional single family home or condominium. For purposes of the Alternative Minimum Tax, however, only interest on real estate loans is deductible – interest on the mobile home or boat loan is not deductible for the AMT.

From a planning point of view, a taxpayer needs to know the AMT consequences of these different types of borrowing. Failure to do so can make a big difference in the actual cost of the loan. If it is deductible, Uncle Sam is paying part of the cost for you; if not, you’re carrying it all on your own.

Investment Interest

Investment interest is interest expense incurred to purchase investments. A margin loan on a brokerage account is an example. This interest expense is deductible to the extent a taxpayer has qualifying investment income. If the expense exceeds the income for any particular year, the excess is carried forward to be used in a future year.

For the Alternative Minimum Tax, investment income is computed the same as it is for Regular Tax purposes, but with a few exceptions.

One exception is private activity bond interest. As discussed in an earlier article, because private activity bond interest is taxed for AMT purposes, it therefore is also included in investment income in computing the allowable AMT investment interest expense deduction.

Other differences follow this same logic, that is, where AMT income is calculated differently from Regular Tax income. One example applies to taxpayers who have rental properties. Here the Regular Tax-AMT difference in computing depreciation directly affects the amount of taxable income from the property, which, in turn, affects the amount of investment income that can offset investment interest expense.

The AMT planning for this is to be aware of the AMT-Regular Tax types of differences that affect income. The more qualifying investment income a taxpayer has, the more investment interest expense he can deduct, keeping the Alternative Minimum Tax burden as low as possible.