Help with mortgage interest tax deduction

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laffsf
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Help with mortgage interest tax deduction

Post by laffsf » Wed Mar 04, 2015 12:37 am

I am looking at Publication 936, and it just doesn't seem to make sense. My situation is:

- Had $400k 2.75% mortgage on home 1 until mid-November 2014
- Took out $1.5m 4.0% mortgage on home 2 in early September 2014
- Paid home 2's mortgage down to $900k after selling home 1

Given that the IRS limits you to deducting interest for $1m of mortgage (or maybe $1.1m, that's not fully clear), one way to calculate would be: 8 months of $400k @ 2.75%, 3 months of $1m @ 4%, and 1 month of $900k @ 4%. That totals out to $7,333 + $10,000 + $3,000 = $20,333.

Reading the publication, however, it looks like I need to take each mortgage and add them both together, for a total mortgage of $1.9m. I then take only 53% ($1m/$1.9m) of the interest paid as deductible. That is a much lower number, and it seems illogical.

Taken to a more extreme example, it seems like holding a single $1m mortgage all year would result in the maximum deduction. But if you swapped like houses with equal mortgages mid-year, you'd have to add the $1m mortgages together and thus only be able to claim a 50% deduction.

Anyone have experience with this?

niceguy7376
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Re: Help with mortgage interest tax deduction

Post by niceguy7376 » Wed Mar 04, 2015 11:36 am

OP,
I have no clue on the situation but would like to give a bump and also learn about this situation.

In our case, we moved from one home to another but the values are quite low compared to yours. We calculated the mortgage as you initially did. Didnt know about the 1 mil mortgage loan for interest deductions.

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laffsf
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Re: Help with mortgage interest tax deduction

Post by laffsf » Wed Mar 04, 2015 1:25 pm

niceguy7376, thanks for the bump. I think as long as both your homes qualify as a first or second home and the total of the two mortgages together is less than $1m, your interest is fully deductible.

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grabiner
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Re: Help with mortgage interest tax deduction

Post by grabiner » Thu Mar 05, 2015 12:25 am

Usual disclaimer: do not treat anything on this forum as tax advice.

As I read the tables on page 12 of IRS Publication 936, you take the average balance of your home acquisition debt ($1M limit) plus home equity debt ($100K limit), and divide it by the average balance of your total mortgage debt, to determine the deductible fraction. Your home acquisition and home equity debt was $400K in January-August, $1.1M in September-November, $900K in December, averaging $617K. Your total mortgage debt was $400K in January-August, $1.9M in September-November, $900K in December, averaging $817K. Thus 617/817 of your mortgage interest would be deductible if the mortgages were held for the full months; the exact numbers would depend on the dates of payments.
Taken to a more extreme example, it seems like holding a single $1m mortgage all year would result in the maximum deduction. But if you swapped like houses with equal mortgages mid-year, you'd have to add the $1m mortgages together and thus only be able to claim a 50% deduction.
This would be covered by a different rule. As long as your mortgage was no more than $1.1M at any time during the year, your interest is fully deductible, even if there is more than one mortgage. (A very common situation would be refinancing a $1M mortgage with a different lender, but selling and buying on the same day is another example.)

(edited to correct numbers)
Last edited by grabiner on Thu Mar 05, 2015 9:19 am, edited 1 time in total.
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Re: Help with mortgage interest tax deduction

Post by Cuzz35 » Thu Mar 05, 2015 1:06 am

Laffsf,

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 would look at the regulation yourself if you can and try that against Grabiner's calculation and choose which gives you the highest deduction. I imagine there will be very little difference.

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laffsf
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Re: Help with mortgage interest tax deduction

Post by laffsf » Thu Mar 05, 2015 8:44 am

Wow, thanks cuzz35 and grabiner for the excellent advice. Given that I paid December's interest in January (and similarly the prior year), would the months of interest for these purposes be December 2013 through November 2014? (Those are months of interest actually paid in 2014.)

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grabiner
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Re: Help with mortgage interest tax deduction

Post by grabiner » Thu Mar 05, 2015 9:25 am

laffsf wrote:- Had $400k 2.75% mortgage on home 1 until mid-November 2014
- Took out $1.5m 4.0% mortgage on home 2 in early September 2014
- Paid home 2's mortgage down to $900k after selling home 1
As an unrelated note, you should either recast or refinance the mortgage on home 2. When you paid down the mortgage from $1.5M to $900K, you didn't reduce the monthly payments (assuming a fixed-rate loan). If you make the originally scheduled payments, you will pay off the mortgage in 14 years, but you will continue to pay the 4% rate for a 30-year mortgage. You can ask your lender to recast the mortgage so that you pay it on the original 30-year schedule, or refinance it to a 15-year mortgage which will be paid off at about the same time but will have a lower interest rate and thus lower payments.
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laffsf
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Re: Help with mortgage interest tax deduction

Post by laffsf » Thu Mar 05, 2015 11:49 pm

Sound advice, grabiner. I actually recast the mortgage when I paid it down. Then rates dipped, so I refinanced to a 3.5% 30 year loan.

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