How is mortgage interest deduction calculated? example: primary home loan 1M, 40K paid in interest all year. Secondary home loan 1M, only $500 paid in interest for the yr

[fgur]

Turbotax adds the loans when calculating the deductible amount and this does not seem right:
(40,000 500)*(750K/2M)
The tool gives both loans the same weight as if they both existed all year, but in my example the second loan was obtained in the last days of the tax year and paid only $500 in interest.

[RaifH]

If you took the second loan in the last days of the year, you can determine the average loan balance for the year using the average of the monthly statements method allowed by the IRS.  You can do this by taking the Outstanding Mortgage Principal reported in Box 2, multiplying it by the number of months you carried the loan, and dividing that number by 12. You can report this calculated amount as the outstanding mortgage principal in Box 2, then when TurboTax asks what the balance was as of January 1, 2022, you will enter the calculated amount again for this loan. 

You can enter the first loan as it is reported on Form 1098 since you carried this one all year. TurboTax will calculate the average balance on this loan using the first and last month's balance, another method approved by the IRS. It will then use the average balance from both loans to correctly apply the mortgage interest limit to determine your deductible interest. 

[fgur]

Thanks a lot. Calculating this way brings the deductible amount to a more reasonable level.

I wonder, though, isn't this a bug in TurboTax? It should make the calculation that benefits the taxpayer the most, and in this case it is clearly not. If we go back to my example:

First loan for 1M, paid 40K in interest throughout the year.

Second loan (for another property) for 1M, paid only $500 in interest for less than a month during the tax year.

Turbo tax calculates:

(40,000+500) * (750,000/2,000,000) = 40,500*0.375 = 15,187.

With the method you described:

For loan #2, the "correct" outstanding principal balance is: 1,000,000/12 = 83,333

Combined deductible for both loans: (40,000+500) * (750,000/(1,000,000+83,333)) = 40,500*0.692 = 28,038.

Turbotax giving you a 15K deductible instead of 28K is quite a big gap.

[ibensi01]

@RaifH do you feel pretty confident in calculating the average home loan value this way (for a loan acquired partway through the year)? It just conflicts with the answer posted here so I want to be sure! 

I want to make sure I'm following the guidance in the IRS guidelines correctly (in the "Statements method, it says to treat the loan balance as 0 in the months that you don't have the loan, which makes sense, but then it also says to divide the sum by the months you have the loan, which would bring the average loan value back to around the original principal amount).

[RobertB4444]

Calculating the the average home loan value the way @RaifH suggests is perfectly in line with IRS guidelines.  And once you total up the average I think you'll find the average loan value is much less.

@ibensi01 

[ibensi01]

Thank you so much @RobertB4444 ! So you would answer this question just posted differently than the current answer by KrisD15?

[PatriciaV]

The difference between the answers is due to the number of monthly payments on the mortgage. The question answered by KrisD15 involved a mortgage that was active for 10 months. RobertB444 answered a question about a mortgage that was secured by the home all year.

@ibensi01