I'm a tax attorney, and I hate to tell you this, but the table in 936 is 100% dead wrong. Using it will hurt you BADLY if you refinance.
The average balance of a loan for the year is NOT the starting balance plus the ending balance divided by two, UNLESS you had the loan for the entire year. If you only had the loan for part of a year, then the average balance is the starting plus the ending multiplied by the number of days you had the loan and divided by 365.
Let's take an example. Mary takes out a $750,000 interest-only bridge loan on January 1 to buy a new house. For the first six months of the year, she pays $10,000 in interest (includes origination fee interest). She then sells her old house, and on July 1, the $750,000 is refinanced into Loan 2 with no cash-out, for which she pays $1,500 in interest for the remainder of the year. Let's say her ending balance is $740,000.
She never had more than $750,000 outstanding, so all $11,500 is deductible.
The IRS worksheet, however, gets this VERY wrong. It would have you ADD the two loans together as if both were in effect the whole year, so that Mary's acquisition debt is $750,000 + $745,000 = $1,495,000. Then it would apply the $750K limitation and only let her deduct about half of the interest she paid. Insanity - and wrong.
Unfortunately, TurboTax does the same thing.
To make it work correctly, you have to enter only ONE loan into Turbotax. In box 1, you put the TOTAL interest you paid for both loans. In box 2, you put the origination date of the earlier mortgage. Then you give the starting balance of the first mortgage and the ending balance of the second mortgage. That gets things right.
