Like many tax questions, the answer to whether or not you can deduct the interest on land that you own is, "It depends." The Internal Revenue Service won't let you deduct interest on a lot that you hold for personal use at some point in the future. However, if the lot is an investment or will be used to build a home relatively quickly, you can deduct the mortgage interest, subject to the usual limitations.
Lot for Personal Use
A lot that you own for your eventual use at some yet-undetermined time in the future isn't tax deductible. To be claimed for the home mortgage interest deduction, a property must meet the IRS definition of a "qualified home." Qualified homes have eating, sleeping and bathroom facilities. Even if you're a very outdoorsy person, a piece of land doesn't have any of these three attributes, so you can't write off the interest. The one potential exception to this is if you buy a piece of vacant land that is adjacent to your existing home with the intent of adding it on to your property. That land is considered a part of your home, like your backyard, for the purpose of taxes on its sale.
Lot for Personal Construction
Interest on land can be deductible if you intend to build a house on it. You can claim a mortgage interest deduction if you will be completing and moving into the home within 24 months of when you start claiming the write-off. The deduction covers your loan on your lot as well as your construction loan, if any. To be able to claim this write off, the house under construction must be your first or second house, and your total mortgage debt must be $1.1 million or less.
Interest on land held for investment purposes is deductible on Schedule E as an investment real estate expense. Schedule E lets you subtract all of your expenses from your rental income to reduce your taxable profit from real estate rental activities. If you don't have any rental income, though, you can only use your losses to reduce your regular income up to $25,000 per year, and only if your adjusted gross income is below $100,000. The write-off provision gradually goes away for AGIs between $100,000 and $150,000, and is completely gone above that threshold.
Investment to Personal
If you already have investment real estate income, it may make sense to buy lots as investments so that you can use their interest to offset the other income and potentially convert them to personal use in the future. Land banking, the process of holding land for long-term appreciation, is a legitimate investment activity. You could also rent your land out for Christmas tree farming or as a parking lot, or even get the owner of an adjacent parcel to rent it so that you won't be able to build on it and block their view. After years of using it as an investment, you may then decide to use it for your own purposes. If you do, it could affect your ability to exclude capital gains when you sell it after building a house on it. It's also significant that you have a legitimate investment purpose that you can document in case the IRS audits.
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