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Help with Mortgage Interest Deduction - Buy/Sell Home

Posted: Mon Mar 11, 2019 11:29 pm
by Nearly A Moose
I could use some help with the home mortgage interest deduction on my 2018 taxes. Pardon the length of the post, but I’m hoping some of the forum’s tax experts are willing to stick it out to help me, as I’m at a total loss. The issue has to with selling a home that was subject to a pre-Dec. 2017 mortgage under the old limit and buying a home in 2018 with a mortgage that is over the new limit. I’ve read Pub 936 several times and have worked through Table 1 several times. But I don’t fully understand how this scenario fits into Pub 936, and I’m confused by the results I’m getting. We’re married filing jointly.

Here’s the scenario:

“Old Home” / “Old Loan”
-Mortgage taken out before Dec. 2017
-Mortgage was always under the $1,000,000 qualified loan limit
-Sold Dec. 14, 2018
-Primary residence through Oct. 2018, then became secondary residence
-Paid $27,797.64 in interest in 2018 per 1098

“New Home” / “New Loan”
-Mortgage taken out Oct. 10, 2018 when we purchases the house
-Initial Mortgage balance $1,366,375 (i.e., over the new $750,000 qualified loan limit)
-Became primary home shortly after purchase
-Paid $8,584.74 in interest in 2018 per 1098


As I read Pub 936, and in particular Table 1 and the corresponding instructions, I only have a few blanks I actually need to fill in, the rest is just calculations:

-Line 1 – Grandfathered debt – none

-Line 2 – Average balance of all your home acquisition debt incurred before Dec. 16, 2017
This is my “Old Loan.” Based on the “Account Balance” method on page 12 of Pub 936, I think I can just take the balance on each month’s mortgage statement, sum them, and divide by 12. I paid my mortgage at the start of each month, so I had a balance each month, and it averaged out to $759,888.50 (if I instead report Dec. balance as zero because of the sale, the average drops to $697,XXX).

Line 7 – Average balance of all your home acquisition debt incurred after Dec. 15, 2017
This is my “New Loan,” and I don’t know how to handle it. If I use the average balance across the three months I had the loan, the average balance would be $1,365454.74. Call this Option A. However, some of the instructions imply I might be able to average the balance across the entire year, in which case the average loan value would be $341,287 (this doesn’t make a lot of policy sense, but I’m just trying to follow the form). Call this Option B.

Line 12 – Enter the total of the average balances of all mortgages from Lines 1, 2, and 7 on all qualified homes
This would be:
$759,888.50+$1,365454.74=$2,125,343 (Option A); or
$759,888.50+$341,287=$1,101,176 (Option B).

If I use Option A for Line 7, Table 1 only lets me deduct $13,008 in interest for the year.
If I use Option B for Line 7, Table 1 lets me deduct $25,106 in interest for the year.

The first outcome makes no sense. The second one doesn’t seem crazy, but the way I computed the average feels a bit odd, and moreover it’s still less than the interest on the “Old Loan,” which would have been fully deductible without question had I not bought the new house.

So, HELP! What am I missing here?

Re: Help with Mortgage Interest Deduction - Buy/Sell Home

Posted: Wed Mar 13, 2019 6:47 pm
by oslocal
Caveat: I'm not a tax professional, so my opinion is how I would view the case as a commoner.

Option B is probably the way to go.
I think if you pick either beginning of the month or end of the month you would end up with a more sensible result.
It doesn't specify, so presumably you could pick either (i) beginning, (ii) end, or (iii) daily average for the transaction months. If I was a juror in tax court, I would certainly think either of these would be a reasonable position to take.

If you pick the beginning of the month version, the math would be as follows:
You should get 759,889 for the old mortgage (per your calculations) and 227,729 for the new mortgage.
759,889 would be the deductible portion, 987,618 would be the total avg balance, and your deductible fraction would be 0.769, so you should deduct 27,978.

Re: Help with Mortgage Interest Deduction - Buy/Sell Home

Posted: Thu Mar 14, 2019 11:48 am
by Nearly A Moose
oslocal wrote:
Wed Mar 13, 2019 6:47 pm
Caveat: I'm not a tax professional, so my opinion is how I would view the case as a commoner.

Option B is probably the way to go.
I think if you pick either beginning of the month or end of the month you would end up with a more sensible result.
It doesn't specify, so presumably you could pick either (i) beginning, (ii) end, or (iii) daily average for the transaction months. If I was a juror in tax court, I would certainly think either of these would be a reasonable position to take.

If you pick the beginning of the month version, the math would be as follows:
You should get 759,889 for the old mortgage (per your calculations) and 227,729 for the new mortgage.
759,889 would be the deductible portion, 987,618 would be the total avg balance, and your deductible fraction would be 0.769, so you should deduct 27,978.
Thanks. This seems to make sense and the number you’re getting is about what I got when I played around with it again last night.

Re: Help with Mortgage Interest Deduction - Buy/Sell Home

Posted: Thu Mar 14, 2019 12:50 pm
by Ketawa
Nearly A Moose wrote:
Mon Mar 11, 2019 11:29 pm
-Line 2 – Average balance of all your home acquisition debt incurred before Dec. 16, 2017
This is my “Old Loan.” Based on the “Account Balance” method on page 12 of Pub 936, I think I can just take the balance on each month’s mortgage statement, sum them, and divide by 12. I paid my mortgage at the start of each month, so I had a balance each month, and it averaged out to $759,888.50 (if I instead report Dec. balance as zero because of the sale, the average drops to $697,XXX).
What is the "Account Balance" method? Do you mean the "Average of first and last balance method"? This should simply be (starting balance + ending balance) / 2. Ending balance is the balance on the last day your mortgage was secured by your home, i.e. the day you paid it off.

You can't use the "Interest paid divided by interest rate" method because the mortgage was not secured by your main home at all times in 2018.

Alternatively, you could mean the "Statements provided by your lender" method for your "Account Balance" method. This provides an alternative in the event that you do not meet the prerequisite of not prepaying more than 1 month's principal and cannot use the "Interest paid divided by interest rate" method because you didn't have the loan the entire year.
Nearly A Moose wrote:
Mon Mar 11, 2019 11:29 pm
Line 7 – Average balance of all your home acquisition debt incurred after Dec. 15, 2017
This is my “New Loan,” and I don’t know how to handle it. If I use the average balance across the three months I had the loan, the average balance would be $1,365454.74. Call this Option A. However, some of the instructions imply I might be able to average the balance across the entire year, in which case the average loan value would be $341,287 (this doesn’t make a lot of policy sense, but I’m just trying to follow the form). Call this Option B.
Same as the above, use one of the appropriate methods, either the "Average of first and last balance" method or the "Statements provided by your lender" method.

"Average of first and last balance" - first balance is not $0, it is the amount on the first day of the year that the mortgage was secured by your home, so the original amount. The last balance is the balance on December 31. Looks to me like a value closer to Option A is the appropriate choice.

Same as above, you can't use the "Interest paid divided by interest rate" method because the mortgage was not secured by your main home at all times in 2018.

"Statements provided by your lender" - Pub 936 says (emphasis added): "For each mortgage, figure your average balance by adding your monthly closing or average balances and dividing that total by the number of months the home secured by that mortgage was a qualified home during the year." You can't spread this over the entire year. It will be close to the "Average of first and last balance" method.

It seems clear to me that something closer to Option A is the correct outcome and only $13,008 is deductible.

The only alternative is if I am misinterpreting the "Interest paid divided by interest rate" method. The example given is for someone who has a mortgage for the entire year.

Re: Help with Mortgage Interest Deduction - Buy/Sell Home

Posted: Thu Mar 14, 2019 1:22 pm
by Ketawa
FWIW, I think it's easy to see the rationale for the various average balance methods if you think about having only 1 mortgage.

"Average of first and last balance method" - works in most cases as long as you didn't prepay principal. Doesn't allow prepayment of principal to avoid cases where a taxpayer pays off a huge chunk at the end of the year to lower the average balance.

"Interest paid divided by interest rate" - you have to have the loan the entire year, otherwise you can't use this. Otherwise, you'd be able to deduct all the interest on a single large mortgage held for a fraction of the year, and I doubt the IRS intends for this to be possible.

"Statements provided by your lender" - the fallback for the most accurate number.

Unfortunately, you are in a case where buying a second home has severely restricted your ability to deduct interest. Looking back at an older version of Pub 936 from before the new tax law (https://taxmap.irs.gov/taxmap2013/pubs/p936-001.htm), this has always been the case. I'm curious if there are older threads on Bogleheads about this issue.

Re: Help with Mortgage Interest Deduction - Buy/Sell Home

Posted: Thu Mar 14, 2019 1:40 pm
by Ketawa
I take back a lot of what I wrote above. Pub 936 is not necessarily the only authority. Read through this thread: Help with mortgage interest tax deduction. Most relevantly:
Cuzz35 wrote:
Thu Mar 05, 2015 1:06 am
There is more than one allowed method to compute your mortgage interest deduction. There is a 2011 IRS letter ruling 201201017 that sights temporary regulation 1.163-10T(e). This essentially outlines the "exact method" of calculating your mortgage interest deduction when more than one house is involved. It works by figuring the deduction on a debt by debt basis. You can take this a step further and look at it on a month by month debt by debt basis. I have helped many clients respond to IRS audits by showing them this source material and the calculation.

So in your situation it sounds like you could fully deduct interest paid in months where all your debt was below the threshold. In the months where you had the $1.5 million debt at 4%, you could deduct interest on $1.1 million the that debt during those months.
I think that calculating the deductible amount on a month by month basis is probably the most logically consistent method. Go through Table 1 in Pub 936 for each month to determine the deductible amount, then add them together.

Re: Help with Mortgage Interest Deduction - Buy/Sell Home

Posted: Thu Mar 14, 2019 3:48 pm
by Nearly A Moose
Ketawa wrote:
Thu Mar 14, 2019 1:40 pm
I take back a lot of what I wrote above. Pub 936 is not necessarily the only authority. Read through this thread: Help with mortgage interest tax deduction. Most relevantly:
Cuzz35 wrote:
Thu Mar 05, 2015 1:06 am
There is more than one allowed method to compute your mortgage interest deduction. There is a 2011 IRS letter ruling 201201017 that sights temporary regulation 1.163-10T(e). This essentially outlines the "exact method" of calculating your mortgage interest deduction when more than one house is involved. It works by figuring the deduction on a debt by debt basis. You can take this a step further and look at it on a month by month debt by debt basis. I have helped many clients respond to IRS audits by showing them this source material and the calculation.

So in your situation it sounds like you could fully deduct interest paid in months where all your debt was below the threshold. In the months where you had the $1.5 million debt at 4%, you could deduct interest on $1.1 million the that debt during those months.
I think that calculating the deductible amount on a month by month basis is probably the most logically consistent method. Go through Table 1 in Pub 936 for each month to determine the deductible amount, then add them together.
Thanks, this is very helpful. I was referring to the "statements provided by lender" method when I said "account balance." I had searched awhile on Pub 936 and mortgage interest deductions, but was having trouble finding posts on this apparently obscure issue. I am going to explore that tax ruling more closely. I really hope that opportunity still exists. I completely understand why I wouldn't be able to deduct all the interest in the months that I'm paying interest on $2.1M of mortgage, but it seems extremely counterintuitive from a policy standpoint that the overall amount of mortgage interest one would be able to deduct in a year would go down substantially simply for having taken out more mortgage.

Re: Help with Mortgage Interest Deduction - Buy/Sell Home

Posted: Thu Mar 21, 2019 9:03 pm
by Nearly A Moose
I thought I'd follow up with a response on what I did in case others come across this post in the future. I'm especially grateful for the reference back to the earlier post (viewtopic.php?t=160076). I read the IRS Letter Ruling (Number: 201201017, here: https://www.irs.gov/pub/irs-wd/1201017.pdf) and IRS Temporary Reg 26 CFR § 1.163-10T (here: https://www.law.cornell.edu/cfr/text/26/1.163-10T). While these both predate the most recent tax law changes, it appears that the rationale remains valid, and the Letter Ruling even explains how the Temporary Regulation remained applicable through one change in how the mortgage interest deduction worked. My read of these sources and the related forum discussion is that the taxpayer must use a reasonable method to apportion interest, and that Pub 936 and the Temporary Reg provide options that a taxpayer *may* use, but isn't required to use. They also reinforce that a taxpayer may make these determinations on a loan-by-loan and residence-by-residence basis.

So, from that, I decided I could justify deducting all of the interest paid on the pre-2018 loan because that balance was always below the then-prevailing $1,000,000 limit. For the new loan secured by a new residence, I determined the average loan balance by adding the beginning and ending loan balances for the year and dividing by two (or in my case, the beginning loan balance at the time I took out the loan plus the end of year balance). I then divided the current $750,000 loan limit by that average to get a ratio. I then multiplied the interest paid on that loan by the ratio to determine who much of that loan's interest was deductible and adjusted the overall deduction accordingly. I documented my work in a spreadsheet and saved the Letter Ruling and Temporary Reg to my 2018 tax year file.

Disclaimer: I'm not a tax lawyer or tax professional, and none of this is tax advice. I might be wrong in my approach. But I think the approach I have taken is reasonable and consistent with the regulation and guidance.

I made a more simplified version of this post that also generated some discussion, and I'm posting the same response there for posterity. Many thanks for the help!

Re: Help with Mortgage Interest Deduction - Buy/Sell Home

Posted: Wed Apr 10, 2019 11:25 pm
by soloekahi
I'm going to revive this topic. I'm in a similar situation and I can't figure out how to calculate the actual deduction properly. Pub 936 is not clear at all but here are my thoughts. If I only owned a home for half the year and bought a new home the second half of the year with a mortgage greater than 750k, then the average mortgage balance for each home would be done using the "Statements provided by your lender" method. I would take the average principal for each month that I had the mortgage secured by my main home and then divide by 12. For example, if my original home mortgage 300k and I only owned it for half the year, the Average Mortgage balance would be 150k. If my new mortgage was 900k, and I had it for half the year then my average mortgage balance for that mortgage would be 450k. This would mean that I could deduct the full interest from both mortgages since the original one was below $1 million and the new one was below 750k and combined they are below 750k.

Next year I would have to take the % of 750k/800k and multiple that by the interest of the new mortgage.

Does that make sense?

From Pub 936
"Statements provided by your lender. If you receive monthly statements showing the closing balance or the average balance for the month, you can use either to figure your average balance for the year. You can treat the balance as zero for any month the mortgage wasn't secured by your qualified home. For each mortgage, figure your average balance by adding your monthly closing or average balances and dividing that total by the number of months the home secured by that mortgage was a qualified home during the year. If your lender can give you your average balance for the year, you can use that amount."

Re: Help with Mortgage Interest Deduction - Buy/Sell Home

Posted: Thu Apr 11, 2019 10:32 am
by Ketawa
soloekahi wrote:
Wed Apr 10, 2019 11:25 pm
I'm going to revive this topic. I'm in a similar situation and I can't figure out how to calculate the actual deduction properly. Pub 936 is not clear at all but here are my thoughts. If I only owned a home for half the year and bought a new home the second half of the year with a mortgage greater than 750k, then the average mortgage balance for each home would be done using the "Statements provided by your lender" method. I would take the average principal for each month that I had the mortgage secured by my main home and then divide by 12. For example, if my original home mortgage 300k and I only owned it for half the year, the Average Mortgage balance would be 150k. If my new mortgage was 900k, and I had it for half the year then my average mortgage balance for that mortgage would be 450k. This would mean that I could deduct the full interest from both mortgages since the original one was below $1 million and the new one was below 750k and combined they are below 750k.

Next year I would have to take the % of 750k/800k and multiple that by the interest of the new mortgage.

Does that make sense?

From Pub 936
"Statements provided by your lender. If you receive monthly statements showing the closing balance or the average balance for the month, you can use either to figure your average balance for the year. You can treat the balance as zero for any month the mortgage wasn't secured by your qualified home. For each mortgage, figure your average balance by adding your monthly closing or average balances and dividing that total by the number of months the home secured by that mortgage was a qualified home during the year. If your lender can give you your average balance for the year, you can use that amount."
Emphasis added to statement from Pub 936 above. If you did not own the home for half the year, you don't get to count those months.

I would go through Table 1 for each month individually. No need to worry about the average balance.