Acquisition Debt: IRS Definition, Limits, and Deductions

Acquisition debt is mortgage debt you took on to buy, build, or substantially improve a home you live in, and it is the only kind of home loan that produces deductible mortgage interest on your federal return. The deduction is capped at interest on the first $750,000 of acquisition debt, or $375,000 if you are married filing separately.¹ Older mortgages get more generous limits, and the One Big Beautiful Bill Act, signed in 2025, made the $750,000 cap permanent instead of letting it sunset after 2025 as the Tax Cuts and Jobs Act originally scheduled.

What Counts as Acquisition Debt

Under IRC Section 163(h)(3)(B), a loan is acquisition debt when two things are true at once: the borrowed money was used to acquire, construct, or substantially improve a qualified residence, and the loan is secured by that same residence.¹

A qualified residence means your main home plus one other home you designate for the tax year. The second home can be a vacation house, a condo, or a boat, provided it has sleeping quarters, a kitchen, and a toilet, and you actually use it as a residence.²

A purchase-money mortgage clearly qualifies. So does a construction loan. Refinancings and home-equity borrowing are where classification gets harder, because the connection between the borrowed dollars and the physical property has to be traceable. Your lender’s Form 1098 reports total interest paid but does not sort acquisition debt from other debt. That job falls to you at filing time.³

Substantial Improvements and the Timing Windows

Not every renovation creates acquisition debt. An improvement is substantial if it adds to the home’s value, extends its useful life, or adapts it to new uses.³ A new roof, an added bedroom, or a full HVAC replacement qualifies. Repainting a room or fixing a faucet does not, though painting costs folded into a larger renovation can ride along as part of the overall project.

The IRS also insists on a tight timing link between the loan and the work:³

If you take the mortgage before the work is finished, it qualifies as acquisition debt up to the expenses you incurred within 24 months before the mortgage date.
If you take the mortgage within 90 days after the work is finished, it qualifies up to expenses incurred during the period from 24 months before completion through the mortgage date.
If you buy a home within 90 days before or after the mortgage date, the acquisition debt is limited to the purchase price plus any qualifying improvement costs.

Financing a renovation six months after it wraps up will not produce deductible interest, even if the loan is secured by the house. The 90-day and 24-month rules exist to keep a direct line between the borrowed money and the property.

The $750,000 and $1,000,000 Limits by Loan Date

The dollar cap on acquisition debt depends on when you took the loan. Publication 936 groups qualifying mortgages into three buckets:³

Grandfathered debt: mortgages taken out on or before October 13, 1987. Interest is fully deductible with no dollar limit.
Pre-2018 acquisition debt: mortgages taken out after October 13, 1987, and before December 16, 2017. These qualify under a $1,000,000 limit ($500,000 if married filing separately), as long as the combined total with any grandfathered debt stayed at or below that threshold throughout the year.
Post-2017 acquisition debt: mortgages taken out after December 15, 2017. These fall under the $750,000 limit ($375,000 if married filing separately).

The caps apply to the principal balance of the loans, not to the interest paid, and they apply across your main home and second home combined.⁴

A binding-contract exception preserves the older cap in narrow circumstances: if you entered a written binding contract before December 15, 2017 to close on a principal residence before January 1, 2018, and actually purchased before April 1, 2018, the $1,000,000 limit applies.³

The OBBBA removed the 2025 sunset that the TCJA had built into these rules. The $750,000 cap now applies to all taxable years beginning after December 31, 2017, with no end date.¹

When Old and New Loans Overlap

Carrying both pre-2018 and post-2017 debt is where taxpayers get tripped up. Pre-2018 debt keeps the higher $1,000,000 cap, but the $750,000 limit for any newer debt is reduced by the outstanding balance of that older qualifying debt.¹

Say you owe $600,000 on a 2015 mortgage and take out $200,000 of new acquisition debt in 2024. The old loan is well under the $1,000,000 cap and qualifies in full. The $750,000 cap for the new loan, though, gets reduced by that $600,000, leaving only $150,000 of room. Interest on the last $50,000 of the new loan is not deductible. Your total qualifying acquisition debt is $750,000, not $800,000.

What Happens When You Owe More Than the Cap

When your total acquisition debt exceeds the applicable limit, you cannot deduct all your interest. Instead, you multiply the interest paid by a fraction: the applicable limit divided by the average balance of your qualifying mortgages for the year.

If you carry $1,000,000 of post-2017 acquisition debt against a $750,000 cap, the ratio is 75 percent. Pay $45,000 of interest that year and $33,750 is deductible.

The IRS accepts two methods for the average balance:³

Average of first and last balance. Add your January 1 balance to your December 31 balance and divide by two. This is available only if you did not borrow more on the mortgage during the year, did not prepay more than one month of principal, and made level payments at regular intervals.
Interest paid divided by interest rate. Divide the year’s total interest by the annual rate. Available if the mortgage was secured by the home all year and interest was paid at least monthly. On a variable-rate loan, use the lowest rate charged during the year.

The first method is simpler but tightly restricted. Variable rates or irregular payment histories generally push you to the second. Reading the year-end balance off Form 1098 is quicker, but the calculation is what governs, and it matters whenever you are above the debt limit.

Refinancing

Refinancing does not by itself strip a loan of acquisition-debt status, but the rules are precise. A refinanced mortgage keeps its acquisition-debt character only up to the principal balance of the old mortgage immediately before the refinancing.³ The statute writes this rule directly into the definition of acquisition indebtedness.¹

Anything above that prior balance is not acquisition debt. Refinance a $400,000 mortgage into a $450,000 loan and only the interest on the first $400,000 stays deductible. The $50,000 of cash-out does not qualify, unless you spend it on a substantial improvement to the home and meet the same timing rules already described.

Pre-2018 acquisition debt refinanced today keeps the $1,000,000 cap, but only up to the remaining principal balance and only for the remaining term of the original mortgage. Once that original term runs out, the refinanced balance drops to the $750,000 cap. Grandfathered debt behaves similarly: refinancing preserves grandfathered status up to the old principal balance and for the remaining original term. If the original loan was not amortized over its term, as with a balloon note, grandfathered treatment carries through the term of the first refinancing, up to 30 years.³

Home Equity Loans and HELOCs

The label on the loan does not decide whether interest is deductible. Use matters. A home equity loan or HELOC spent on substantial improvements to the home securing the loan functions as acquisition debt and produces deductible interest. A HELOC used to pay off credit cards, cover tuition, or take a trip does not.³

Before 2018, interest on up to $100,000 of home equity debt was deductible no matter how the money was spent. The TCJA killed that catch-all, and the OBBBA made the elimination permanent.¹ Home equity debt used for non-home purposes is now permanently non-deductible.

When a HELOC does qualify because you used it for improvements, it counts toward the same $750,000 combined limit as your primary mortgage. If your first mortgage balance is $700,000, only $50,000 of a qualifying HELOC produces deductible interest.

Proving the improvement connection is on you. Keep contractor invoices, materials receipts, bank records of the draws, and a timeline tying the borrowed funds to the work. The IRS will not take your word for it if the return is examined.

You Have to Itemize

The mortgage interest deduction lives on Schedule A. Take the standard deduction and none of your acquisition-debt interest saves you anything, no matter how much you paid.³ For 2026, the standard deduction is $32,200 for joint filers, $16,100 for singles, and $24,150 for heads of household.⁵ The deduction only helps if your total itemized deductions, mortgage interest plus state and local taxes plus charitable contributions plus other qualifying items, come in above that floor. On smaller loans or later in a loan’s life, when payments run mostly to principal, the standard deduction often wins. Rerun the comparison every year.

1
Office of the Law Revision Counsel. 26 USC 163
2
Internal Revenue Service. Instructions for Form 1098 Mortgage Interest Statement
3
Internal Revenue Service. Publication 936 – Home Mortgage Interest Deduction
4
Internal Revenue Service. Publication 936 – Home Mortgage Interest Deduction
5
Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026