California Mortgage Loan Balance Information

[vadimy]

I have entered three 1098 Forms into the Deductions section of my Federal tax return.  I purchased a house in 2019 with two loans, and afterwards refinanced with another lender with a single loan. Therefore the breakdown looks roughly like this:

1098 for Lender 1:  Outstanding Mortgage $450,000 (Original loan #1)

1098 for Lender 2: Outstanding Mortgage $670,000  (Original loan #2)

1098 for Lender 3: Outstanding Mortgage $1,120,000 (Refinanced loan #3, combining balances for #1, & #2)

In the California state section, TurboTax gives me a table with two columns of interest:

Borrowed in 2019         2019 ending balance

450,000

670,000

1,120,000

What are the appropriate amounts to put in here? Should the be $0 for the two initial loans, or should these amounts be equal to the original loan amounts since they were immediately refinanced?

Thanks in advance!

[veroweb01]

Based on what you've noted, I read that Mortgage #1 & #2 were paid off with Mortgage #3.  If this is in fact true and correct, both M1 & M2 have a remaining balance of Zero ($0.00) at the end of 2019.  For Mortgage 3, if you made any payments in 2019, the remaining balance should be less than the original amount financed.  The 'remaining balance' for 2019 should be at the bottom of your 1098 for Mortgage #3.  At least that's where it is on mine. (remaining balance is the 'principal remaining balance'.

Best

[vadimy]

Thanks veroweb01! I played around with the California form some more, and here are some observations/thoughts. I am hoping a tax expert can chime in here and confirm or correct my assumptions.

For Federal taxes, the interest on a home loan is only deductible for up to $750,000 for married.  If for example the average home loan balance for the year is $1.5M, the interest paid would only be deductible for up to 50%.  (750,000 / 1,500,000 = 0.5).  So for example, if the 1098 form said that you paid $20,000 in interest across your loan(s), you could only deduct $20,000 * 0.5 = $10,000.  Turbo tax offers a simple text box to enter the negative adjustment value (e.g. -$10,000). Note that the loan balance is calculated as the average for the tax year, so for example let's say it was $1.55M on Jan 1st and $1.45M on Dec 31st, the average would be $1.5M, as used in the example above. [I should also add here that it would be nice of Turbo Tax did this calculation for you by asking for the relevant values, rather than just given you a text explanation. After all this is why people pay for tax software].

Moving on to California.  This state has a higher limit on mortgage interest deductions; it is $1M, instead of the Federal $750,000.  I believe the intention here is to calculate how much extra interest could be written off based on the higher state limit.  Here's where I'd like Intuit experts to double check my assumptions and math.  Using the same figures as above, the average loan balance was $1.5M.  The deduction multiplier based on CA limits is ($1,000,000 / $1,500,000) = 0.666...etc (Let's round up to 0.67).  So for $20,000 of interest reported on 1098,  $20,000 * 0.67 =  $13400 would be deductible. This is $3400 over the Federal deduction, so TurboTax allows you to manually enter this adjustment value (as -$3,400) later on in the mortgage section.  This manually entered value appears to override anything TurboTax calculates internally, which is somewhat opaque to the user.

Now as far as multiple loans go.  If we go with veroweb01's suggestion, and say that original loans #1 and #2 are effectively $0 at end of year, I believe what this does is skews the calculation of the average loan balance. For example, let's say the $1.55M house was funded by (#1) a $1M loan and (#2) a $550K loan, which were immediately refinanced into a single (#3) $1.55M loan:

Loan        Start Balance     EOY Balance___Average Balance

$1.0M           $1.0M              $0                     $0.5M

$0.55M         $0.55M           $0                     $0.275M

$1.55M         $1.55M            $1.45M           $1.50M

Under these assumptions, loans #1 and #2 had a combined average of $775,000, which is well below the California limit, allowing you to deduct the full interest amount. For loan $3, the calculation is the same as above, based on the ($1.0M / $1.5M) multiplier of 0.67.

If however you update the table above to reflect that Loans #1 and #2 were combined into a new loan, the numbers change quite a bit:

Loan        Start Balance     EOY Balance___Average Balance

$1.0M           $1.0M              $1.0M                     $1.0M

$0.55M         $0.55M           $0.55M                  $0.55M

$1.55M         $1.55M            $1.45M                 $1.50M

Now the interest for loans #1 + #2 is based on the average loan value of $1.55M, so it needs to be adjusted based on the CA maximum.

There are two possible adjustments that could be made here:

1. Instead of reporting the unchanged loan balance for EOY, it can be reduced by the same fractional amount of that the new loan was paid off.  So for example since the new loan went from $1.55 to $1.45, the ending balances of #1 and #2 could be adjusted to be 0.935 of their starting values. That way the interest on these two loans is deductible up to the same fraction as the interest on the new loan.

2. The average could be calculated based on the effective balance on each loan at the time they were combined into the new loan. For me personally this happened very quickly, so the balance was effectively unchanged, however one could imagine a scenario where the refinancing happened later in the year, where the loan balances were slightly over.

So summarize the options,  I still would like to know which one is correct for CA tax purposes

Option 1: report the two initial loans as having a $0 balance for end of 2019, where the average becomes (#1 + #2) / 2.

Option 2: report the two initial loans as having their initial unchanged balance for end of 2019, where the average becomes (#1 + #2).

Option 3: calculate a theoretical balance for the two initial loans, as if they had been paid at the same rate as the new loan.

Option 4: take the exact balance of the two loans at the time of refinancing, and use that value to calculate the average value for the year.

Each option leads to a different outcome. #1 gives you the most money back, #2 gives you the least. #3 makes the final numbers indistinguishable from having a single loan for the entire year, and #4 is somewhere in the middle, depending on the exact timeline of refinancing.

Thanks to all in advance! 

[jcore58]

Similar (kind of) question.  I have 2 properties that I claim 1098 mort. int deduction and included (in Federal section), the "current" o/s principal balance amounts (eg: as of 12/31/19).  When doing California, TT carried these balances forward to Cal return as "beginning of year" balances and the Cal. section wants me to enter in end-year.  Seems to be a mistake and won't allow to edit the beg of year with correct amounts (same as end-year 2018). 

[DianeC958]

You will need to edit the information for you mortgages in the Federal Section of TurboTax.  If you look at Box 2 for Mortgage Interest it is asking for the balance due as of 01/01/2019.

Once you change the information on the Federal side to reflect the beginning balance due for 2019 then repopulate your California return.

[Brett_C]

Vadimy,

I'm in the same boat.  Did you get an answer on how to handle the refi of a loan during 2019?

[rogelio_1]

This problem is well described in the below thread:

https://ttlc.intuit.com/community/tax-credits-deductions/discussion/re-i-refinanced-and-have-two-109...

There is an issue in how the program performs forced calculations of the average mortgage balance for CA with an additional 1098 / refinanced loan.  There is an open investigation for me personally, with no end date described.  Many irate people on this thread encountering the same issue you're alluding to.

[rogelio_1]

@Vadim 

Of all your options, if you look at the actual tax forms, none of them will generate a truly accurate worksheet which is supposed to be defensible to the IRS.  This is because the worksheet performs the forced calculation incorrectly which carries in to the average mortgage balance, as you've pointed out, when you have loans that were closed out into a refinance.  Unless TT has follow-up questions or a way to flag in the CA state questions that the loan was for a Refi (which it DOES NOT ask), there is no way for its logic to accurately populate the worksheet (and thus average mortgage balance).

The options TurboTax have  left us all with is ingenious because it abdicates them from liability (in lieu of patching the issue, which they seem to not be doing at this point) -- if you make the changes you suggest (to get the system to accurately calculate your average balance), you are providing inaccurate information on your loans, and TurboTax will not provide support to you in the case of an audit because the information you provided is incorrectly entered into the worksheet.

[vadimy]

Hi folks,

No I have not received any support from Intuit. This still appears to be an unpatched issue, and it's not clear if there is a fix forthcoming. 

Here's what I ended up doing based on my best reading. These are Google Sheets formulas, should also work in Excel. The numbers are made up for the sake of the example.  

For this example there are 3 lenders. The house was originally financed by Bank 2 and Bank 3 with initial loan amounts of $1,000,000 and $510,000.  The loans were then quickly re-financed to Bank 1 for a total of $1,510,000. During 2019 the hypothetical person paid down $20,000 in principal.

	A	B	C	D	E	F	G	H	I
1	Lender	1098 Int	Loan SOY	Loan EOY	Loan AVG	FED MULTIPLIER**	CA MULTIPLIER***	FED MAX	CA MAX
2	Bank 1	$20,000	1,510,000	1,490,000	1,500,000	=IF(E2<750000,1,750000/E2)	=IF(E2<1000000,1,1000000/E2)	=F2*B2	=G2*B2
3	Bank 2	$5,000	1,510,000*	1,510,000*	1,510,000
4	Bank 3	$3,000	1,510,000*	1,510,000*	1,510,000

Notes:

*Since the loans from Bank 2 and Bank 3 represent one property, I combined their amounts to show what I believe is the true loan total. Otherwise smaller individual loans can fall below the Federal and State limits, which would make their 1098 interest fully deductible, which I don't believe is the intention.

** This is a value <= 1.0. For loans <= 750,000 this value is exactly 1.0, so the full 1098 interest is deductible.

For a $1,500,000, the multiplier is 0.5.

*** This is a value <= 1.0. For loans <= 1,000,000 this value is exactly 1.0. For larger loans it is < 1.0. 

The final two columns represent the total maximum deductible values for Federal and for California. The first amount can be entered into the Federal return as the adjusted total (which is smaller than the sum of the 1098 interest across all forms).   For California, I believe you can adjust for the difference between Federal and California maxima, i.e. this is the extra interest that could have been deducted if the federal limit were the same as California's.

<y two cents. Sure would be nice to get an official blessing/debunking of this idea. 😃

[cherry532]

It is very funny that I have one loan refinanced twice and transfered four times. I ended up with 6 1098.

My balance of loan never exceed 1.5M but turbotax thinks I have an average balance of 3.57M!!!

If you want to figure out what actually is happening, go to the form view, look for "Deductible Home Mortgage Interest Worksheet" and see how turbo tax is coming up with the number for you. Then you can figure out which box is probably done wrongly. In my case, it looks like turbo tax just can't handle more than 5 1098 forms because the form only has 5 entries for each 1098. The 6th is just missing and ignored for the calculation for my case!!