Help with Mortgage Interest Limitation

[BenB03]

Hi all,

I'm having a bit of difficulty understanding Pub 936 and was wondering if someone could check my calc using the Average First and Last method. Numbers are rounded below for simplification. No loans began before 2017 and all are subject to the $750,000 limitation. Activity during 2022 includes:

- Sold my primary residence in WA on 12/05/2022

- Used my HELOC (secured by WA property) to purchase my new primary in NC (paid off at 12/05/2022)

- Purchased NC primary on 7/08/2022

	Beginning Principal	Ending Principal	Average
WA Property	$500,000	$490,000	$495,000
NC Property	390,000	380,000	385,000
HELOC	105,000	105,000	105,000
Total			$985,000

So I would take $750,000/$985,000 = 76% and apply that to the total mortgage interest or am I missing anything here? Should I be factoring in the duration that I held each loan (ex: NC mortgage only applicable for 5 mo.) or am I okay as is?

Thanks!

[PatriciaV · Accepted solution]

Your method for calculating average balance appears to be sound. However, you may wish to compare the results when using the weighted-average method, which may allow you a greater interest deduction. See IRS Pub 936 Statements Provided by Your Lender.

Weighted average takes into account the number of months a loan was active during the year. As a shortcut, you can use your average (first + last / 2) and multiply it by number of months / 12. For example, if your NC loan was active for 5 months, the weighted average would be 385,000 x 5/12 = 160,416.

[BenB03]

Hi Patricia- This is ultimately how I ended up computing the adjustment and did yield a greater interest deduction. Thank you!!

[tbain98]

@PatriciaVPub 936 says "dividing that total by the number of months the home secured by that mortgage was a qualified home during the year." For the NC loan that was held for only 5 months, doesn't that result in $385,000 x 5/5 = $385,000? Or is there some precedent for considering a property owned for only part of the year to be a qualified home for all months in the year?

The divide-by-12 approach would mean that a $2mil loan balance held for only 4 months would be fully deductible, whereas the law says we're capped at $750k for "any period." To me that seems like the divide-by-12 method may be not compliant with either the Pub or the underlying law. Is there something I'm not aware of, or any case law or IRS guidance to indicate that this is indeed a valid way to compute this? (I'd love that because it would benefit my taxes this year, but want to make sure it's actually valid before I apply something that's beneficial to me.)

[DMarkM1]

@TBain  I refer to Publication 936, the Average Mortgage Balance section, Examples 1 and 2.  Both annualize the mortgage debt.   

Further, using an example of two loans.  One home that was sold in May with an average balance during only those months of 600,000 (below 750) along with a home purchased in July for 605,000 so an average balance of 600,000 for only July - Dec.  Never was the indebtedness over 750,000, but if they are not annualized the aggregate is going to be 1,200,000 and limit the deduction. 

However, if annualized and aggregated the interest is deductible as it should be. 

[tbain98]

@DMarkM1Thanks for the response, I appreciate you sharing your expertise!

> @TBain I refer to Publication 936, the Average Mortgage Balance section, Examples 1 and 2. Both annualize the mortgage debt. 

If I understand correctly, the difference between that example and this situation is that Sharon from the example owned the property for all 12 months of the year, whereas that is not the case here. Pub 936's Statements Provided By Your Lender section says "dividing that total by the number of months the home secured by that mortgage was a qualified home during the year" and I believe a home is not a qualified home during the months you don't own it. Or am I thinking about this wrong in some way?

> Further, using an example of two loans. One home that was sold in May with an average balance during only those months of 600,000 (below 750) along with a home purchased in July for 605,000 so an average balance of 600,000 for only July - Dec. Never was the indebtedness over 750,000, but if they are not annualized the aggregate is going to be 1,200,000 and limit the deduction.

I agree that the instructions in Pub 936 result in a limitation that seems incorrect in the case of non-overlapping mortgages. But I'm not convinced that makes the divide-by-12 method a valid alternative in all cases, since that leads to loans over $750k (or multiple properties that sum to over $750k) held for short periods of the year being treated as unlimited even though the mortgage balance for that period of time is above the limit. The only approach that seems correct in all these scenarios is dividing the interest paid across different periods of the year, computing the sum of average balances for each period and applying the limitation to each period. Then mortgages over $750k are properly capped, as are short periods when multiple properties are owned whose mortgages sum to over $750k.