Deductible home mortgage interest with multiple homes

[MV80]

I have got two homes bought in 2015 and 2016 for personal use, these are not rental properties. I bought another home and sold one of the first two in 2020 giving me three 1098 forms. As these homes were bought in different "eras" (different deduction limits apply) the Deductible Home Mortgage Interest Worksheet is supposed to merge them but it does it in the "strange" way. It calculates some kind of factor on line 15 by dividing the mortgage balance from 1987 to 2017 era with the balance from all mortgages combined. Then it multiplies the total interest from all mortgages combined with that factor. This effectively means the bigger my 2020 mortgage is, the lower my mortgage interest deduction is which is totally counter-intuitive. Am I entering my 1098 forms incorrectly, is there a bug in Turbo Tax or, if none of the previous two is correct, can I just drop the 2020 mortgage from the tax return?

[NCperson]

can you provide some detail on the dollar value of each of the 3 mortgages? I suspect you may be running into the limitation on deductible interest if the sum of the mortgages exceeds $750,000.  that would help understanding what you are dealing with. 

[MV80]

Yes, of course. Here is a simplified example with two instead of three mortgages. Lets start with the mortgage from 2016 with an average balance of $1,000,000 and interest of $20,000 for the last year. Since the limit for a pre 2017 mortgage is $1,000,000, all $20,000 of its interest is deductible.

Now, lets add a 2020 mortgage of $2,000,000 and the same interest of $20,000. This can be because a banker is my friend or the mortgage simply started later in the year, I think it does not matter. Here is the worksheet taken from TurboTax verbatim and filled with the above numbers. Notice how it calculates my deductible to be only $13,333 this time, but I would expect it to remain $20,000. And if I increase the amount of the second loan further, my deductible will go down. Also notice the instruction for line 18 from the sheet. It calls for subtracting the factor from amount which is obviously wrong.

Part 1 - Qualified Loan Limit
Qualified loans acquired prior to October 14, 1987
1	Average balance of debt acquired prior to October 14, 1987 (grandfathered debt)
Qualified loans acquired after October 13, 1987 and before December 16, 2017
2	Average balance of debt acquired after October 13, 1987 and before 12/16/17	1000000
3	Enter $1,000,000 ($500,000 if married filing separately)	1000000
4	Enter larger of the amount on line 1 or the amount on line 3	1000000
5	Add the amounts on lines 1 and 2. Enter the total here	1000000
6	Enter the smaller of the amount on line 4 or the amount on line 5	1000000
Qualified loans acquired after December 15, 2017
7	Average balance of debt acquired after December 15, 2017	2000000
8	Enter $750,000 ($375,000 if married filing separately)	750000
9	Enter larger of the amount on line 6 and the amount on line 8	1000000
10	Add the amounts on lines 6 and 7. Enter the total here.	3000000
Total qualified loans
11	Enter the smaller of line 9 or line 10. This is your qualified loan limit	1000000
Part 2 - Deductible Home Mortgage Interest
12	Enter the total of the average balances of all mortgages from lines 1, 2 and 7 on all qualified homes. See the line 12 instructions	3000000
13	Total amount of interest that you paid on the loans from line 12 reported on form 1098	40000
14	Total amount of interest that you paid on the loans from line 12 not reported on form 1098
15	Divide line 11 by line 12	0.333
16	Multiply line 13 by the decimal amount on line 15. Enter the result. This is deductible home mortgage interest for loans reported on form 1098 Enter this amount on Schedule A line 8a	13333
17	Multiply line 14 by the decimal amount on line 15. Enter the result. This is deductible home mortgage interest for loans not reported on form 1098. Enter this amount on Schedule A line 8b	0
18	Subtract line 15 from line 13. This is not home mortgage interest

[ineedhelp2021]

im no expert, but i don't see a problem with your math... the problem is due to the disconnect between principal and actual interest paid... you are being penalized for having a cheaper loan.

if it had been a more expensive loan (say 50.000 interest ) you would be able to go above the  "caped" value from the 1st loan : (20000+50000)*.3333 = 23.000 

if its a really cheap loan (say 5.000 interest ) you would be better off not claiming the deduction : (5000 + 20000)*.3333 = 8.000 

using the principal to reduce the interest without considering the interest rate is where this goes "wrong"....

[MV80]

That "penalty" does not make sense. In any case, I "solved" the problem by dropping the third mortgage since the replaced property was sold at the end of December and one can claim at most two homes. The third mortgage would have not made any difference. Since the remaining two mortgages were from the same pre 1027 era, the worksheet calculated the correct value.

[NCperson · Accepted solution]

your example assumes the $2mm mortgage was taken out on Jan 1 so the math presented is reasonable.

But the word 'average' needs more in depth discussion.  This is the world of the IRS  and not of the common man! 

the worksheet you filled out is from Page 12 of this document published by the IRS, so they are The Truth:

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

if you read on page 13 there is a whole discussion on 'average' - I kid you not! 

while the two point average is good enough for a mortgage you've had all year, it really doesn't work if another mortgage is introduced later in the year (or paid off). 

Let's say Mortgage 1 is $500,000 and Mortgage 2 is $300,000; both were taken out after 2017 so the limit if $750,000 appears to have been pierced.  

but let me change the facts.  Mortgage 1 was taken out in 2018 and Mortgage 2 was taken out in December 2020.   Is the average for 2020 still $800,000?  Or is it $500,000 for 11 months and $800,000 for the 12th month, meaning the average for the year is only $525,000 (11 months at $500,000 and 1 month at $800,000).

Yes, in 2021 you are over the $750,000 threshold, but not in 2020

Look at the Mr. Blue example in the middle column of page 13.  because it divides back the actual interest by the interest rate to get to the average balance , in effect you are not getting "hit" for the months the $300,000 mortgage doesn't exist.

Let's say the $500,000 mortgage was at 4% and the $300,000 was at 5% and originated in December. 

The $500,000 mortgage: $20,000 / 4% = $500,000 - no shock here. 

the $300,000 mortgage: $1,250 of interest (December only) / .05 = $25,000!!!!!!!!! NOT $300,000!!!!!

The "averages" you would add together is $500,000 and $25,000!!!!! 

So 'average' doesn't necessarily mean a two point average, especially in a year that a new mortgage is introduced or an old mortgage is extinguished!!!  see how that affects your worksheet; I suspect you'll get a better answer!!!! 

ps would have been so much easier and straight forward if the IRS just said to take a 12 point average and use zero for the months that mortgage did not exist because it either originated or paid off.   BUT NO, they go through this whole convoluted approach of interest / interest rate and never directly say what the purpose is! 

Hope this helps! 

[MV80]

Thanks, I see what you mean. But the thing is, that was not "my" worksheet. It is build into TurboTax and I only copied it into the post. But I shall worry about it next year, I already submitted the return for 2020.

[NCperson]

@MV80 - that worksheet is from the IRS - publication 536