Acquisition Debt is the amount of money borrowed used to buy, build or improve a principal residence or second home. Under the new tax law, mortgages taken after 12/14/17 are limited to a combined Acquisition Debt total of $750,000 on the first and second homes. The mortgage interest on this debt is tax deductible when itemizing deductions.
It is a dynamic number that is reduced with each payment as the unpaid balance goes down. The only way to increase acquisition debt is to borrow money to make capital improvements.
Prior to the new law, homeowners could additionally borrow up to $100,000 of home equity debt for any purpose and deduct the interest when itemizing deductions. Mortgage interest on home equity debt is no longer deductible unless it is for capital improvements.
Acquisition debt cannot be increased by refinancing. Some confusion occurs because mortgage lenders make home loans to be repaid according to the terms of the note and using the home as collateral. But, that alone does not qualify a mortgage as tax-deductible.
Another thing that adds confusion to the issue is that lenders annually report the amount of interest paid, but only the amount that is attributable to acquisition debt is deductible.
Even if the interest on a cash-out refinance is not deductible, it may be advantageous to replace higher interest debt such as credit card debt with lower interest mortgage debt.
It is the responsibility of the taxpayer to know what part of their mortgage debt is deductible. The challenge becomes more difficult after a cash-out refinance. Homeowners should keep records of all financing and capital improvements and consult with their tax professional.