What is Acquisition Debt
Acquisition debt is a financial obligation incurred during the construction, improvement or purchase of a primary or secondary residence. A home mortgage loan is an example of acquisition debt. The Internal Revenue Service (IRS) (IRS) provides certain tax advantages for home acquisition debt.
BREAKING DOWN Acquisition Debt
Taxpayers can deduct the interest paid during the tax year for mortgages that qualify as home acquisition debt. The IRS considers home acquisition debt to be any mortgage after Oct. 13, 1987, that was used to buy, build or substantially improve a main or secondary home. The mortgage must also be secured by that home. If the mortgage amount is more than the cost of the home, plus the costs associated with any substantial improvements, only the debt that is not greater than the cost of the home plus improvements will qualify as home acquisition debt. The IRS limits the total amount of mortgage debt that can be treated as home acquisition debt. The total amount cannot exceed $1 million, or $500,000 if a married couple is filing as separate taxpayers.
Under the Tax Cuts and Jobs Act, which passed Congress in December 2017, beginning in 2018, the amount of home acquisition debt (for new loans) that can be deducted will decrease, to $750,000 ($375,000 for married couples filing separately). The IRS considers an improvement to be substantial if it adds value to the home, extends the home's useful life or adjusts the home to new uses.
Acquisition debt can pose a risk if the borrower does not generate sufficient funds to cover required debt payments. This proved to be the case during the financial crisis that began in 2007. In response, Congress passed the Mortgage Forgiveness Debt Relief Act to allow homeowners whose lenders had forgiven part of all of their mortgage loans to avoid having to include the forgiven amounts in their income for tax purposes. According to the provision, “taxpayers may exclude from income certain debt forgiven or canceled on their principal residence.” As outlined in the Act, the exclusion applied to "qualified principal residence indebtedness.”
Acquisition Debt and Corporations
Businesses often use acquisition debt as a way to avoid issuing too many additional shares, which would be dilutive to shareholders and do damage to their stock price, and to benefit from favorable tax treatment for debt. Acquisition debt might include bridge (short-term) loans, borrowings available under their existing revolving credit lines, and bonds. Often companies plan to reduce acquisition debt via a term out, or replace it with longer term loans and bonds, and using cash flow generation to pay down borrowings. This minimizes the company exposure to floating interest rates by locking in the interest rates. Extended the term of debt obligations also preserves financial flexibility by allowing the company to spread its debt payments over several years.