@DMarkM1,
Is there anything from the IRS indicating that averaging the balance across all 12 months of the year (including months when the property was not owned by the taxpayer) is valid? Pub 936 says you can treat those months where the mortgage wasn't secured by a qualified home as having a zero balance, but then says "dividing that total by the number of months the home secured by that mortgage was a qualified home during the year." For a home that was bought or sold during the year, that seems like you don't get to divide by 12 but rather by the number of months you owned the home during the year.
The law (h.3.B.ii) underlying the Pub doesn't get specific about this, but does say "The aggregate amount treated as acquisition indebtedness for any period shall not exceed $1,000,000" (now $750k), which sounds to me like it would conflict with jennamahoney3@'s conclusion that all interest was deductible despite having a balance over $750k for a period of the year. And that makes me question the validity of the divide-by-twelve method of computing the average balance at all.
I'm leaning towards allocating interest towards each of three separate time periods (when I owned only home 1, when I owned both homes 1 & 2, and when I owned only home 2) and computing Table 1 for each period and then summing them as the approach that seems most in keeping with the intent of the law. But I'm concerned about the fact that it goes against the instructions in Pub 936 which say to list all debt for the year when computing Table 1. Is there any case law or official guidance from the IRS about this specific question?
