Following the order of the issues described in our previous overview article, here is a look at how they apply to a personal residence:

Interest expense

Interest paid on a loan secured by a taxpayer’s home, referred to in the tax law as “qualified residence interest,” is deductible for purposes of the Regular Tax, subject to a few limitations.  Interest on home acquisition debt is deductible in full to the extent the mortgage does not exceed $1 million, as is interest on home equity debt to the extent the debt does not exceed $100,000.  Home equity debt, typically a second mortgage or a home equity line of credit, can be used for any purpose – a car loan or a child’s education are examples.

Under the AMT, a taxpayer is allow a full deduction for home acquisition debt.  For home equity debt, however, it is AMT-deductible only if it is used to improve the residence, i.e., if it used for other purposes, such as the car loan or student loan mentioned above, it is not deductible for the AMT.

Planning idea – look to alternative means of financing instead of home equity debt when financing automobile purchases, college tuition, or other personal purposes.  A special-offer automobile loan at 1.9%, for example, certainly would be less expensive financing than a home equity loan for an AMT payer.

Property taxes

Property taxes are allowed in full for Regular Tax purposes, but, along with all other state and local taxes, are not allowed at all as a deduction for the Alternative Minimum Tax.

Planning idea – if you have an opportunity to pay your property tax bill either this year or next, pay it in a year that you are not in the AMT.  Depending on levels of income, itemized deductions and other factors, taxpayers may find themselves in the AMT one year but not the next.

Example – in Florida, property tax bills are mailed in October, and are payable under the following discount schedule: November – 4%, December – 3%, January – 2%, February – 1%.  If you are in the AMT in 2010 but expect not to be in the AMT again in 2011, do not pay your bill in November or December  - forgoing that small discount could save a taxpayer up to 39.6% of the amount of the property taxes on his Federal income tax bill next year.

Depreciation

Depreciation does not apply to a personal residence, except perhaps for a taxpayer claiming a portion of his residence as a “home office” or other business use.  This topic will be discussed in some detail under the topics of rental/investment property and business property in the next two articles in this series.

Active/passive investment rules and the “at-risk” rules

Similar to Depreciation, these rules will be discussed in the next articles in this series; they do not apply to property held as a personal residence.

Sale of the property

A sale of a personal residence is not taxable to the extent the gain does not exceed $500,000, for a married couple filing jointly, or $250,000 for a single taxpayer.  Any gains over these amounts are taxable, as long-term capital gains.  Capital gains in and of themselves are not an AMT item, but they nonetheless can result in AMT being paid.  This is because the AMT exemption amount is phased out for taxpayers at certain income levels, so this additional income can have the result of reducing the exemption which, in turn, increases taxable income for purposes of the Alternative Minimum Tax.

This issue is discussed in some detail in an article posted on amtblog.com on December 13, 2009.  This article also can be found by doing an internet search for “alternative minimum tax planning – investments – capital gains.”

Next in this series on Real Estate and the AMT – property owned as rental/investment property.

Here are the things we will be looking at:

Interest expense

Except for anyone who travels in the Buffet/Gates social circles, every purchase of real estate will be financed.  Financing, in turn, means that interest will be paid.  In general, the tax law allows a deduction for this interest for Regular Tax purposes, although a number of different limitations can apply.  These limitations vary, depending on whether the property is a residence, or is rental/investment or business property.  The separate AMT limitations that apply to real estate also vary among these categories.

Property taxes

Property ownership brings with it the obligation to pay property taxes.  In general, for Regular Tax purposes real estate taxes are deductible regardless of the reason for holding the property.  This is not the case for Alternative Minimum Tax payers, however, for whom the deduction may be totally disallowed in some situations, yet allowed in others, depending on which of the three classifications applies.

Depreciation

Depreciation is a deduction that allows a taxpayer to recover the cost of an investment in property, depending again on the taxpayer’s purpose for holding the property.  If depreciation deductions are allowable, the AMT has a set of rules different from the ones that apply for purposes of the Regular Tax.

Active/passive investment rules and the “at-risk” rules

In some cases the tax law’s active vs. passive investment rules, and/or the at-risk rules, will apply to individuals owning real estate.  These are overarching rules that supersede the other individual tax law limitations.  Even if they do apply, however, an AMT payer still must keep track of the separate AMT calculations required by the other limitations.

Sale of the property

Very few taxpayers hold on to property for life; at some point in the future it can be expected that the property will be sold.  A number of special Regular Tax rules apply to the sale of real estate, and, in most cases, an AMT payer will have a different set of calculations to make.

Conclusion

Real estate is one of the biggest purchases most taxpayers make, and it is likely there will be a number of real estate purchases and sales throughout the taxpayer’s lifetime.  The Regular Tax rules are complicated enough, but additional wrinkles exist in the calculations for Alternative Minimum Tax payers.  With a little knowledge, however, these complications and wrinkles can present some real tax planning opportunities for AMT payers.

The next article in this series will address the specific tax issues for real estate owned as a personal residence – certainly the most common form of property ownership.

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.