Deductions & credits

Your interest is not fully deductible, but it sounds like you will have to make some manual adjustments.  The IRS has no automatic way of knowing you claimed too much interest deduction, but if audited, you will have to prove how the money was used, and any disallowed deduction will result in back taxes with interest.

 

You can deduct mortgage interest on acquisition debt.  Acquisition debt is debt used to buy, build or substantially improve your home.  You have to trace all the money from each loan.  For example:

 

Loan 1 is the purchase mortgage, used only to buy the home.

Loan 2 is an equity loan that was not used to buy, build or improve the home.

In 2020, you refinanced to a single loan 3.  Assume the balance on loan 1 was $150,000, the balance on loan 2 was $27,000 and the balance on loan 3 is $177,000.  Your acquisition debt is $150,000, so only 84% of the interest on loan 3 is tax-deductible.  100% of the interest on loan 1 (that you paid before the refinance) is deductible, and none of the interest on loan 2 is deductible.

 

Turbotax may not do a good job of calculating deductible interest in your situation, but I have not tested this situation.  If you can answer the questions to get this result, it's correct. But if it seems wrong, you may need to get more help on how to enter the correct amount of deductible interest.  

 

Next year, you can assume that you are paying off the equity portion first.  So in my example, your loan as of January might be 84% acquisition debt (150,000/177,000) and by December, it might be 88% acquisition debt (if you paid off $7000 of the equity portion and the loan was now 150,000 acquisition/170,000 total).