Deductible Mortgage Interest Questions w/ Balances Above $750k, Exact Method

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hbomb272
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Joined: Tue Apr 02, 2024 5:39 pm

Deductible Mortgage Interest Questions w/ Balances Above $750k, Exact Method

Post by hbomb272 »

For tax year 2023 I owned a condo which was my primary residence until I purchased a house on 8/29/23. When I purchased the house that residence became my primary residence and the condo became my second home. Neither home is rented for any portion of the year.

Below are the terms of the loans for 2023. Based on the origination dates I am subject to the combined $750,000 cap on mortgage amount for the mortgage interest deduction.

Condo Loan (Original Primary Residence but became Second Home on 8/29/23)

Origination Date – August 2021

Average balance for 2023 - $458,000

Interest Rate – 2.625%

Interest Paid in 2023 – $12,048 (Monthly Average of $1,004)

Home Loan (New Primary Residence)

Origination Date – 8/29/23 (1st Payment in October 2023)

Average balance for 2023 – $725,000

Interest Rate – 6.875%

Interest Paid in 2023 - $12,465 (3 Months starting in October, Monthly Average of $4,155)

Since the new house/mortgage is at a much higher interest rate I want to claim 100% of this mortgage interest as deductible and then claim any remaining balance up to the $750k limit from the second home/other mortgage. Logically this makes a lot of sense, since my primary residence is the basis for the majority of the deduction, not my second home.

Initially I read Publication 936 which would divide $750,000 by the combined balances of the mortgages together to determine an eligible percentage, and then apply that percentage the combined total interest paid. However, this would result in a lower deduction than what I proposed above, both this year and especially in future years, since my condo/second home loan is at such a lower interest rate. It also doesn’t work correctly for 2023 since I didn’t own both residences for the entire year.

From there I scoured forums and the internet to see if there are other options and learned of the "exact method" of calculating the mortgage interest deduction when more than one house is involved. As I understand it, it works by figuring the deduction on a debt-by-debt basis relative to the limit and you can take this a step further and look at it on a month-by-month debt-by-debt basis.

I also 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.

I also found reference to this document from 2018 and on page 14 and 15 the exact method is referenced with an example (not specific to a second home, however). https://cdn.ymaws.com/www.oatc-oregon.o ... s_2018.pdf

Based on these sources and the related forum discussions it appears 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.

My key questions are:

Am I understanding the rules and intent correctly?

Is the below a correct application of the “Exact Method”?

Is the below an accurate and acceptable way to calculate deductible mortgage interest for tax year 2023?



January through September - $1,004 deductible interest each month ($458k Average Balance (on my then Primary Residence) is below the $750k Cap) for a 9-month total of $9,036

October through December - $4,210 deductible Interest each month ($725k Average Balance on my new Primary Residence @ $4,155 Average Monthly Interest PLUS $25k/$458k of my Second Home = 5.459% x $1,004 Average Monthly Interest = $55) for a 3-month total of $12,630

TOTAL Deductible Interest = $21,666 for 2023



Theoretically and for simplicity in calculation, if 2024 has the same average balances and average monthly interest amounts, would the below be an acceptable calculation of deductible mortgage interest for 2024?

Primary Residence - $725k average balance, $4,155 average monthly interest x 12 = total interest of $49,860 (this would theoretically be the figure shown on the Form 1098)

Second Home - $25,000/$458,000 = 5.459% x $12,048 total interest = $657

TOTAL interest deduction - $49,860 + $657 = $50,517
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