Paying cash can be a big advantage when buying a new home. After all, you don’t need to do the onerous paperwork and your offer is very likely to be accepted! However, this is not a decision to be made without a discussion with your CPA. Did you know that if you pay cash for a home, and decide to get a mortgage later, you may not be able to deduct the majority of the mortgage interest?
Most homeowner’s know they can deduct the interest on their mortgage (up to $1,000,000 of acquisition indebtedness on their principal residence) but they may not understand the limitations of such debt. Acquisition debt is the amount used to buy, build or improve a person’s principal residence. The amount is not static but changes over time. An amortized loan reduces the principal owed with each payment made and the acquisition debt is reduced accordingly. If a person stays in a home long enough to retire the loan, the acquisition debt is reduced to zero. Likewise, if a borrower pays cash for a home, the acquisition indebtedness is zero. Our current tax laws allow a homeowner to deduct the interest on the acquisition debt plus the interest on up to an additional $100,000 home equity debt. So, if you pay cash for your home and take out a mortgage later, you likely will be only able to deduct the interest on the first $100,000 of the new loan amount. Thousands in tax write offs could be lost each and every year. Make sure to check with your CPA to see if paying cash makes ‘tax sense’ for you.