The IRS allows various methods to determine your average balance. Either way, the final average balance will determine the deductible interest.
The formula is:
Deductible Interest = Total Interest Paid times ($750,000 divided by Average Balance)
Here is my easy method - note you can make it more complicated*
Interest for short term loan is limited:
- Deductible % for short term mortgage $750,000 divided by $775,000} = 96.77%
- Deductible interest 96.77% times total interest paid
Interest on refinanced loan is below the limit and fully deductible.
Add the deductible interest for each loan for the total allowed.
*instead of using $775,000 as the average balance - you can refine it with the average balance for each month and divide by 3. It won't be a big change. You can use alternative methods in IRS Pub 936.
To determine your average balance, you need to determine which method you want to use and document your process.
The link will show you the options and give examples. You do not qualify for average of first and last balance method or mixed use. This leaves two options. The interest rate method may be your best bet but check the statements provided by your lender option as well.
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