Tax Implications of Negative Amortization

If you've been considering implementing Negative Amortization into your Mortgage Plan then you are probably wondering the same things:

"What are the tax implications on negative amortization? If you are paying less than interest only and your home mortgage increases can you still write off your depreciation? Can you write off depreciation on your home or just investment property? Let me know."

You can only take depreciation expense on your investment properties, not your primary residence) and depreciation, by definition, is the writing off (deducting) of an expense over time versus in a single year.  Officially, I’m unfamiliar with any particular guidance from the IRS, but logically speaking I have to presume the following:

Negative Amortization increases your loan balance over time, say you start with a balance of 100k and end up with a balance of 110k.  The 110k is what is called your “basis” in the property.  To calculate your taxable gain on the property you would take your sale price (less selling expenses) and subtract your basis.  For example, if you sold the house for 150k and had a basis for 110k then your taxable gain is 40k. 

So, does Negative Amortization let you cheat the IRS out of money?  The answer is obviously no.  Your Uncle Sam always gets paid.  That 10k in Negative Amortization that increased your basis over time was simultaneously decreasing your monthly payment (increasing your monthly cash flow).  Thus, because your monthly net cash flow was higher your overall tax liability is higher, so you are theoretically paying more taxes over time.

With Negative Amortization:

Basis in your property = Increases                       Taxable income on a sale = Decreases

Monthly mortgage payment = Decreases Taxable rental income = Increases

            

This doesn’t consider the impact of depreciation recapture and other tax implications.  You should always consult your tax or legal advisor before making these types of decisions.  If you don’t work with a tax or legal advisor that is investor friendly then feel free to contact us for a referral.