Changing the mortgage PRINCIPAL balance (not the interest paid) changes the tax owed - WHY??

[bagofchips]

I have a $830K mortgage on a home purchased in 2011.  So it's grandfathered above the $750K limit which began in late 2017. I'm married filing separately which means I can ONLY itemize deductions.

Weird things happen when I change the "principal balance" (line 2/box2) of the mortgage data entry.  If I enter the $830K from the start of the year (per the 1098) and change nothing else, I get FED taxes owed of about $19.7K.  If I lower the principal amount to around $500K the FED taxes drop to $16,055. And they stay that way if I take it down to $1.  If I drop the principal literally to 0, the fed taxes change to a whopping $25.7K.

This seems kinda screwy.  Why does the principal balance affect Fed (and state) taxes owed, if the entered mortgage interest itself has not even changed??

[Mike9241]

if you change the balance to zero, none of the interest would be deductible show up on schedule A. as MFS your debt limit is only $500K not $1 million

[bagofchips]

Thx for the fast reply, on Apr 14 nearing midnight west coast, no less, one day to go. Yeah changing it to zero was obviously just an edge case to see how the thing was working.  I forgot about how (of course) the MFS would split-allocate principal balance and therefore the interest so that mostly explains.  Though, now here's what's weird, it seems to be "giving" me about 60% (not 50%) of the mortgage interest.  ($16K of $26.7K) when I look at the interest on Sched A vs the interest worksheet.  (Sounds like I'll be buying audit defense.)

[Mike9241]

the proration is 500/830 which is the 60% however, if you been paying down the principal you deduction could actually be 500 divided by the average balance for the year. 

[bagofchips]

Thx ok so I see now how 60% can arise. So what if the spouse filing separately enters the same numbers? Does that lead to another 60%, yielding 120% of mortgage interest getting used?

[RobertB4444]

It would, yes.  So in your case the principal should be $415K for each of you so that you are dividing things evenly.  Or, if you are going to weight heavier for one of you, the other should only use the remaining amount of the 830K (ie 500 + 315, etc).

@bagofchips 

[Opus 17]

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@bagofchips wrote:

Thx ok so I see now how 60% can arise. So what if the spouse filing separately enters the same numbers? Does that lead to another 60%, yielding 120% of mortgage interest getting used?

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Each spouse should only list the portion of interest they pay, and never more than the total (when combined).  If you are living together in harmony and sharing funds, you can divide the interest any way you like.   If you are separated, you would divide the interest based on your separation agreement or any court order. 

(For example, suppose spouse A makes 75% of the marital income and spouse B makes 25% of the income, and the separation order requires spouse A to pay 75% of the mortgage.  Spouse A would list 75% of the interest and spouse B would list 25%.  Then, the limit calculation is applied, so spouse A would actually get to deduct 75% x 60% = 45% -- which is still 60% of the share they actually paid.)