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Mortgage interest deduction on mortgages over 1 million

Technical topics regarding tax preparation.
#1
evadtax  
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Hello,

I have a case where a client had two primary residences in the same year (of course, not at the same time). First property with mortgage balance of approx. 500k was converted to rental end of May and the new primary residence was purchased on June 1st with a mortgage over 1 million (1.2M). The question is how to determine the deductible interest. In my opinion, the interest on the mortgage for the first part of the year should be fully deductible (while the property was used as a primary residence) as the mortgage was below 1M. And the second mortgage should be averaged as it is explained in the Pub 935 (value as of June 1st and Dec 31st added up, then divided by 2). And, finally, the interest paid on that second mortgage (for the last 7 months of the year) would be prorated with 1 million rule in mind. Of course, the remaining part of the interest for the converted property goes to Schedule E. Am I thinking this correctly?
 

#2
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Sounds good to me.
 

#3
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Just keep in mind that the limit is actually $1.1M.
 

#4
evadtax  
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Got it. No home equity debt. Just an unusual "primary residence converted to rental then purchase of a new residence" type of situation. Could not find any similar cases anywhere on the web. Thanks.
 

#5
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evadtax wrote:Got it. No home equity debt. Just an unusual "primary residence converted to rental then purchase of a new residence" type of situation. Could not find any similar cases anywhere on the web. Thanks.


All qualified acquisition debt is also equity debt, that is why the limit is $1.1M
 

#6
Keyad22  
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evadtax wrote:Got it. No home equity debt. Just an unusual "primary residence converted to rental then purchase of a new residence" type of situation. Could not find any similar cases anywhere on the web. Thanks.



CCA 200940030

a taxpayer with a mortgage larger than $1 million can treat the first $100,000 in excess of the $1 million limit as home equity indebtedness because it is other debt secured by the home.
 

#7
BTJig  
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I had 1040 examination where I had to educate the agent why the taxpayer did not literally have to have a HELOC in order to be eligible do deduct the interest on $1.1MM. Schedule A exam looking at mortgage interest expense only. I provided everything she asked for, and she allowed only the interest on the first $1MM, disallowing the remainder. I was able to provide enough support, including the CCA above, to get her to issue no change.
 

#8
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Also Revenue Ruling 2010-25, its official IRS position.

More discussion,

https://www.journalofaccountancy.com/is ... 13910.html
 

#9
Lalva  
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I have a similar situation and I want to be sure I am doing this correctly.

My client sold his primary residence in March 2017 (with mortgage under $1 Million), bought another one with a mortgage of $1,500,000. The loan was refinanced for the same $1.5 MM a few months later. So we have 3 loans.

My analysis is that the interest for the 1st loan is fully deductible because the mortgage was under the limit. The other two loans averaged $238,000 and $594,000. Can they take the interest deduction in full this year? I think so but I would like your input.

Next year the limitation will apply.

Thanks!
 

#10
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Lalva wrote:I have a similar situation and I want to be sure I am doing this correctly.

My client sold his primary residence in March 2017 (with mortgage under $1 Million), bought another one with a mortgage of $1,500,000. The loan was refinanced for the same $1.5 MM a few months later. So we have 3 loans.

My analysis is that the interest for the 1st loan is fully deductible because the mortgage was under the limit. The other two loans averaged $238,000 and $594,000. Can they take the interest deduction in full this year? I think so but I would like your input.

Next year the limitation will apply.

Thanks!


I am not sure what the $238k and $594k are supposed to be, but it doesn't sound like the interest will be fully deductible. The mortgage on the home that was $1.5M will not be fully deductible.
 

#11
Lalva  
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I run the numbers in my software (ProSeries Professional) and because we need to calculate the average mortgage balance it was fully deductible, because the big loans were in place for just a few months, not the full year. Next year of course it won't be fully deductible since the mortgage is over the limit.

I want to make sure this sounds correct.
 

#12
Lalva  
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The $238k and $594k are the average balance for the two new mortgages for the year. It's in the IRS worksheet in Pub 936.
 

#13
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It sounds like you are trying to use the average of first and last balance method to average the loan. You can only use that method when there is no new borrowing during the year. Since there was new borrowing during the year, that method should not be used. You didn't really provide the details but I would confirm your conclusion using the interest paid / interest rate or the statement balance methods.
 

#14
dave829  
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I don’t understand where you’re getting $238,000 and $594,000 either. It seems to me that the average debt was between $1 and $1.5 million.

For example, suppose that the mortgage debt on the old residence was $800,000, and that the home was sold on 3/1/2017. That’s 2 months X $800,000 = $1.6 Million.

Next, suppose that the mortgage debt on the new residence was $1.5 Million, and that this debt existed from 3/1 to 12/31/2017. That’s 10 months X $1.5 Million = $15 Million.

The instructions for line 2 of the worksheet say to add these together ($1.6M + $15M = $16.6M) and divide by 12 ($16.6M / 12 = $1,383,333).
 

#15
Doug M  
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You can also use the exact method to find out if it gets you a bigger deduction.

You compute the interest on a debt by debt basis under the exact method. There is a temp reg out there, but it only discusses how to use the exact method when the average balance of the debt exceeds the adjusted basis of the property. And it is not even mentioned in Pub 936
 

#16
Lalva  
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Thank you all for your valuable help.

TaxMonkey, you are correct, the method I was using was the average of first and last balance method, which is the only my software uses, apparently, and I cannot use it because of the refinancing.

So then, how can I calculate the deductible mortgage interest? Should I use the full interest for the home that was sold in March, and then prorate the interest for the first $1.1 MM of mortgage for the mortgages in the home they bought? They don't have a HELOC or home equity loan.

Thank you again.
 

#17
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The method that you end up using will depend on the information that you have available. If you have all the monthly statements available, then you can go payment by payment each month and prorate the interest - 1.1M / total principal balance * interest payment.

If you don't have all of that information you can work with just the total interest paid on all loans for the year, and the lowest interest rate on any of the loans, which gives you a safe but less taxpayer friendly number. Total interest on all loans / lowest interest rate = Avg loan balance for all loans for the year
 

#18
Lalva  
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I have finally received information from my client, however, there are statements missing for the mortgage on the house they sold, so I cannot use the principal method.

Now it looks like the method I would be using is the interest paid divided by the lowest interest rate. Do I include all the mortgage interest, even the one that is under the $1,000,000 limit, for the house they sold?

If I include it, the average balance comes up around $1,200,000. The mortgage balance in the house sold is around $400,000, and the mortgage in the new house is around $1,430,000. The total interest paid in the old house is around $6,000 and the interest paid in the new house (original mortgage and refinancing) is $37,600.

So if I include all the interest and divide it by the lowest interest rate (3.625%) the result is $1,200,000. And using $1,100,000 in the worksheet in Pub. 963, page 11, I come up with a deductible amount of $39,800. Does it sound correct?

Thank you so much for your help
 

#19
Chay  
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TaxMonkey wrote:If you have all the monthly statements available, then you can go payment by payment each month and prorate the interest - 1.1M / total principal balance * interest payment.


You don't need the monthly statements If you have the origination date, the beginning and ending balances and the total interest paid for the year. In that case you can derive the rate of interest and the amount of each monthly payment using an Excel spreadsheet. I've done this before.
 

#20
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Chay wrote:
TaxMonkey wrote:If you have all the monthly statements available, then you can go payment by payment each month and prorate the interest - 1.1M / total principal balance * interest payment.


You don't need the monthly statements If you have the origination date, the beginning and ending balances and the total interest paid for the year. In that case you can derive the rate of interest and the amount of each monthly payment using an Excel spreadsheet. I've done this before.


LOL sounds a lot easier to get the monthly statements. But yes, given enough information then maths.
 

#21
Lalva  
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Thank you all for your help.

Does the $1,200,000 average balance look correct to you?
 

#22
Lalva  
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I don't have anyone around to double check. I really appreciate your help!
 

#23
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You have used rounded numbers, but the overall process looks correct to me.
 


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