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Smurfette
Returning Member

Can I choose which mortgages to use for interest deduction?

Hello.  I'm married, so the IRS allows me to deduct interest on $750,000 worth of mortgages.  I had three mortgages in 2020 (all are recent so none are grandfathered):

 

  1. Original mortgage on primary home purchased in 2019 (this mortgage was refinanced Sept 1, 2020 - see next bullet), interest rate is 3.625%
  2. Refinance mortgage on primary home, which covers Sept-Dec 2020, interest rate 2.625%
  3. Mortgage on second home, which I sold in June 2020, interest rate 3%

The mortgage on my primary home is big.  If I use the "interest paid divided by interest rate method" from Publication 936 on mortgage #1 above, which calculates the mortgage balance by dividing the interest I paid from Jan-August 2020 by the interest rate of 3.625%, the balance is above $750,000.  I'd like to use only this mortgage when calculating my tax deduction as doing so will yield the best result, since the interest rate is higher than the others.  Can I do this, or am I obligated to include the other mortgages as well?

6 Replies
Opus 17
Level 15

Can I choose which mortgages to use for interest deduction?

You are unnecessarily limiting yourself.  You can deduct mortgage interest on your main home, that includes both mortgages if you refinanced during the year.  If we assume the balance is $1 million, then you can deduct 75% of the interest you paid for the entire year, including both the original loan and the refinanced loan.

 

Taxpayers can also deduct interest on one second home, but since you are already over the $750,000 limit, there's no point in entering the second home. 

*Answers are correct to the best of my ability at the time of posting but do not constitute legal or tax advice.*
Smurfette
Returning Member

Can I choose which mortgages to use for interest deduction?

Thanks so much for your reply @Opus 17 - very much appreciated!  I'm still a bit confused.  I'll walk through my math below (ignoring the mortgage on the second home for simplicity).  Note that I got these calcs from Table 1 of Publication 936.

 

 A) Period coveredB) RateC) Interest paidD) Implied balance (C/B)
Primary mortgageJan-Aug 20203.625%$34,776.92$959,363.31
Refinance mortgageSep-Dec 20202.625%$7,366.01$280,609.90
Total  $42,142.93$1,239,973.22

 

Interest deduction calculations:

 

 Primary Mortgage OnlyPrimary Plus Refinance Mortgage
E) Implied balance (from D above)$959,363.31$1,239,973.22
F) Limit$750,000.00$750,000.00
G) % of interest deductible (F/E)78.2%60.5%
H) Interest paid (from C above)$34,776.92$42,142.93
I) Interest deductible (G*H)$27,187.50$25,490.23

 

The "primary mortgage only" option gave me the bigger deduction.  Do I have this wrong?

Opus 17
Level 15

Can I choose which mortgages to use for interest deduction?

I haven’t looked at the specific worksheet, I tend to look more at the fundamentals rather than exactly how it’s calculated. I can try and look at the worksheet later if no one else answered this question. I’m confused about your implied balance, did you take a cash out refinance with equity for more than the original mortgage? Did you take a second mortgage and not pay off the first mortgage?

*Answers are correct to the best of my ability at the time of posting but do not constitute legal or tax advice.*
Smurfette
Returning Member

Can I choose which mortgages to use for interest deduction?

Thanks again @Opus 17.  I did not do a cash-out refi - it was just a standard refinance.  The "interest paid divided by interest rate method" is described in Publication 936.  See below for a copy-paste of the relevant section.  My take is that it's a method designed to deal with situations like this, where the mortgage balance needs to be adjusted down to account for the fact the mortgage only covers part of the year.  I'm no expert though, so it's very possible that I've misunderstood.

 

Intuitively, it makes sense I think.  The IRS only lets me deduct interest on $750K of mortgage value.  If I have more than $750K in mortgages, and I'm allowed to allocate mortgage dollars to the $750K limit as I please, allocating the highest-rate mortgage will maximize my deduction.  I don't see why doing this would be prohibited, but figured I should check.

 

---

 

Interest paid divided by interest rate method.

 

You can use this method if at all times in 2019 the mortgage was secured by your qualified home and the interest was paid at least monthly.

 

 

 

 

Complete the following worksheet to figure your average balance. 

 

1.Enter the interest paid in 2019. Don't include points, mortgage insurance premiums, or any interest paid in 2019 that is for a year after 2019. However, do include interest that is for 2019 but was paid in an earlier year_____
2.Enter the annual interest rate on the mortgage. If the interest rate varied in 2019, use the lowest rate for the year_____
3.Divide the amount on line 1 by the amount on line 2. Enter the result_____

 

Example.

 

Mr. Blue had a mortgage secured by his main home all year. He paid interest of $2,500 on this loan. The interest rate on the loan was 9% (0.09) all year. His average balance using this method is $27,778, figured as follows.

1.Enter the interest paid in 2019. Don’t include points, mortgage insurance premiums, or any interest paid in 2019 that is for a year after 2019. However, do include interest that is for 2019 but was paid in an earlier year$2,500
2.Enter the annual interest rate on the mortgage. If the interest rate varied in 2019, use the lowest rate for the year0.09
3.Divide the amount on line 1 by the amount on line 2. Enter the result$27,778

 

Opus 17
Level 15

Can I choose which mortgages to use for interest deduction?


@Smurfette wrote:

Thanks again @Opus 17.  I did not do a cash-out refi - it was just a standard refinance.  The "interest paid divided by interest rate method" is described in Publication 936.  See below for a copy-paste of the relevant section.  My take is that it's a method designed to deal with situations like this, where the mortgage balance needs to be adjusted down to account for the fact the mortgage only covers part of the year.  I'm no expert though, so it's very possible that I've misunderstood.

 


I don't think that method applies to a refinance.  You didn't have one loan the whole year, you had two loans each for part of the year.  And if you did use that method, the instructions you quoted say to use the lowest interest rate.  I will look a little farther. 

*Answers are correct to the best of my ability at the time of posting but do not constitute legal or tax advice.*
Smurfette
Returning Member

Can I choose which mortgages to use for interest deduction?

Thanks @Opus 17.  Curious to hear how you would recommend calculating the deduction.  I tried using TurboTax and ended up with $17K, which sounds way too low.  Given that one rate is 3.625% and the other is 2.625%, it seems that the right answer should be somewhere between $19,688 ($750,000*2.625%) and $27,188 ($750,000*3.625%).

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