Mortgage Interest Limitation Calculation

How does everyone do this calculation?

For example say someone had a mortgage on a primary residence in the amount of $400k. They then buy a vacation home with a mortgage of $700k on 7/1.

I have seen the calculation done 2 ways:

1. The initial $400k is fully deductible. The new mortgage is limited to $350k worth of interest or 50% of the interest. This seems like the logical way to do it.

2. You look at the balances weighted based on number of days. So you have $400k on the first mortgage since it was open for 365 days. 2nd mortgage was only in place for 183 days so the actual balance for the calculation is only $350k. By doing it this way, you are under the $750k total balance for the year and therefore 100% of the interest is deductible. This is how my old firm used to do it and it definitely leads to a much better result for the client.

Its sure does, but it is wrong.

Method 2 is referred to as the "Average of first and last balance method" in IRS Pub 936, or Treas Reg 1.163-10T (h)(5) and you are only allowed to use that method when you didn't borrow any new amounts during the year.

For years in which you have new loans you must use one of the other methods.

Assuming interest-only acquisition mortgage loans of $400k & $700k.

For the first half of the year, you had $400k mortage, interest on which is deductible since it's , $750k.
For the second half of the year, you had $1.1M mortgage, interest on $750k of which is deductible, so prorate it 750/1,100.

so prorate it 750/1,100.

Another option would be to prorate only the second loan 350k/700k, which is what the OP suggested in option #1.

Thanks for the feedback!