Deductible home mortgage calculation

[Stonks]

Hi,

I got a mortgage that was over $750,000. Given that I can only deduct interest on the first $750,000 but I made extra principal payments taking it under $750,000, I wonder about the calculation.

Originally, in January, I owed over $800,000 but then I made an extra principal payment taking it under $750,000. This means that all the interest paid starting March (and some part of February) could be deducted?

Does TurboTax have any way of handling extra principal payments (I know the date I made the extra principal payment taking it under $750,000 but that doesn't show on form 1098). Will TT just do $750,000/original which would give a lower percentage?

Thanks!

[zomboo]

The interest deduction is not based on mortgage balances month-to-month. It is based on the average monthly balance. TT calculates the average balance by summing the beginning and ending balances and dividing by 2. This is not the proper averaging method to use this year if you made an additional principal payment of over $50K to bring your mortgage balance below $750K.

You should use the Statements Provided By Your Lender method described in Pub 936. With a majority of your monthly balances below $750K, this method could yield most or all of you interest deductible.

[DaveF1006]

It depends. Here is how your mortgage limitation is applied and i will illustrate with a screenshot in the end of this post.

There is no method in Turbo Tax that will give you an exact month by month calculation to determine the accuracy of the limitation. Instead,  it will give you an average balance of the difference between your beginning balance as of 01/01/2024 and ending balance at 12/31/2004.

Hypothetically, if we have a $800,000 balance in the beginning and $748,000 (which would include your principal paydown) as of 12/31.The average balance is $774,000 between the two amounts. Now let's assume you paid $30,000 in mortgage interest. Here is how the limitation is calculated. ($750,000/$774000)($30,000) =$29,070. If you look at IRS publication 936, page 11 uses the same worksheet as I illustrate below thus Turbo Tax follows the same method of calculating the mortgage interest limitation. 

[zomboo]

@DaveF1006 The Average of First and Last Balance method described on page 13 of pub 936 only applies if you don't prepay more than 1 month's principal during the year. If the extra principle paid by @Stonks was more than one month's worth of principle, the Statements Provided By Your Lender should be used to calculate the average balance.

[Stonks]

Hi,

Thanks so much for your answers to both of you. I just wonder if my understanding might be correct in the following now. You are saying TT is calculating the mortgage average balance with (start+end)/2 by default. This might not be the best if I paid too much principal.

For instance, if the original loan was 1m and the ending is 700k, that average would be 850k even if most of the time it was lower than 750k. But, if originally I had 850k and I paid so much that I ended with 500k, then the average will be less than 750k anyway (675k), allowing me to deduct everything.

Is this correct? I'm asking because I'm actually in the second situation. I overpaid so much principal that (start+end)/2 < 750k. Would this mean I can maximize the deduction with the default calculation?

Also, in my case, I think it would be lower than 750k even if I calculate the average by using each month closing balance. I prepaid too much early in January. I haven't checked if this calculation is also lower than 750k but I can give that a try. It seems I would be forced to use this method due to prepaying over 1 month in principal.

Thanks again!

[zomboo]

I was just pointing out that when paying all that extra principle, you are not allowed to used the (start+end)/2 average. You have to use the monthly ending balances from your statements. But if both methods result in an average less than $750K, it doesn't matter which method you use. All interest is deductible.

[NCperson]

@Stonks look at the bottom of page 12..lower left. 

https://www.irs.gov/pub/irs-pdf/p936.pdf

assuming you had a fixed rate mortgage, just take the total interest and divide it back by the interest rate.  THAT is the average balance for the year.  Is that under $750,000? if yes, then all the interest is deductible. 

[Stonks]

Hi @NCperson,

That actually makes sense too. It says I can do that as long as the interest was fixed and the mortgage was secured by main home during the year (both of which are true). My interest was ~6.5% and I paid about $41k in interest, the division gives less than $750k.

As a note, box 7 is not checked but box 8 has the same address with different spacing / naming (abbreviations in one and not in other). It is indeed my main and only home (and I live here).

So, based on all this, I should be able to claim is my main home in TT and deduct the full interest. Hopefully it will all work (first year that I will itemize instead of claiming the standard deduction).

Thanks so much everyone (@zomboo , @DaveF1006, @NCperson)!