How do I handle the sale of a home equity financed vacant lot on which I intended to build?

by Jim
(Waukesha, WI, USA)

We purchased a lot in December 2007 with the intention of building within 8 months. We paid cash, but financed it with a HELOC of over $110,000. No payments were made in 2007.

We were unable to sell our home, so we did not build in 2008. We wrote off all the interest on the HELOC on our 2008 taxes. I recently read something about a $100,000 limit on home equity deductibility.

(Q1) First off, did we write off too much?
(Q2) Secondly, at what point does the lot become viewed as investment property, ineligible for home equity deductibility?

Now in June 2009, we are trying to sell the lot, on which we expect to take at $25,000 loss.

(Q3) What are the tax implications here?
(Q4) What about the interest I deducted already on what turned out not to be a primary residence?

Thanks for your advice.

Hi Jim,

Thank you for your question.

According to the IRS Publication 530, "Usually, you can deduct the entire part of your payment that is for mortgage interest, if you itemize your deductions on Schedule A (Form 1040). However, your deduction may be limited if:

1) Your total mortgage balance is more than $1 million ($500,000 if married filing separately), or

2) You took out a mortgage for reasons other than to buy, build, or improve your home.

In addition, IRS Publication 936, says that you can deduct home equity line of credit interest limited to $100,000 if it is used for investment.

So, to answer your questions (Q1) and (Q2): I believe you can only deduct up to 100,000 of the loan interest as investment interest on Schedule A.

(Q3) Your 25,000 loss may be limited to a 3,000 deduction each year.

(Q4) When you sale the lot at a loss, there shouldn't be any impact with regards to the interest already deducted.

Thanks again for your contribution.