Mortgage interest deduction seems to be incorrect

[CornerWings]

Hi,

Below is our homeowner situation,

* Home A purchased in 2018

* Purchased Home B in Jun 2021 and paid same points

* Loan for Home B got transferred in Aug 2021

* We could not move into Home B immediately as we did some remodel and continued living in Home A until Jan 2022

So I am planning to treat Home A as our primary home and Home B as secondary home for tax purposes. Here's where things are strange,

* When I add my first 1098 for Home A, all of the interest shows up as deductible (which is correct because outstanding balance on this loan is lower than 750k limit)

* As mentioned above I have two 1098 for Home B, one of them shows points (original lender) and other one shows rest of interest for the year. Initially I just added the most recent 1098 (one which doesn't have points), strangely the deductible interest decreases. Even after I add the other 1098 with points, it doesn't seem to make a difference at all.

Can anyone help me understand what is going on here? I am still confused as to why the deductible interest would actually decrease if I add 1098 for my second home.

I assumed we could deduct Home A interest fully, and portion of Home B's interest until we hit the 750k limit. Does turbotax merge all outstanding loans and interests together and simply applies limit on overall interest?

[RaifH]

Yes, your average loan balance is calculated by determining the average loan balance for the year on all outstanding loans. The limit is then applied to the total interest paid on all loans. 

TurboTax determines the average loan balance for each outstanding loan by taking the first and last month's balance, a method approved by the IRS. This works fine for the home you owned all year, but for the home you purchased mid-year, you would be better served by using a different IRS method, the average of the monthly statements. 

To determine that, I would take the outstanding mortgage principal reported in Box 2 of the original Form 1098 for the new home, multiply that number by the months you had the new home, and divide by 12. That will lower the average balance reported for this loan, which will increase the deductible interest on all your loans. Since you got two 1098s for this loan when one company acquired it from the other, to make things simpler, I would combine the two entries into one 1098 into TurboTax to more easily navigate the entries. When you report Form 1098 for your new home, enter it this way:

1. Box 1 Mortgage interest - Add the amounts together from both 1098s
2. Box 2 Outstanding Mortgage Principal - Use the average monthly statement calculation
3. Box 3 Mortgage Origination Date - Use the date on the first 1098 when you purchased the home 
4. Boxes 5 & 6 - Use the combined totals from both 1098s
5. Make sure Box 7 is checked

In most cases, you will be able to deduct the points from your new home purchase in their entirety. However, to do this, you will need to mark the new home as your main home. That's fine, since that it is what it will end up being. Make sure to change Form 1098 for your old home to indicate it is for a second home. 

[CornerWings]

Thanks for the detailed answer.

One clarifying question from the IRS doc, it mentions "You can treat the balance as zero for any month the mortgage wasn't secured by your qualified home". Does the months that we did not have a mortgage fall under this bucket which I believe is your suggestion?

[nnsquare]

I understand that I can use zero as the mortgage balance for the months following he sale of the home since the mortgage has been paid off at the time of the sale. I can then manually calculate the loan average balance using the IRS's alternative method. But, how o I enter this manually calculated average balance in turbotax? How do I make turbotax use the alternative IRS method for calculating the average balance?

[DMarkM1]

Enter it into box 2 of your form 1098 entries for "Oustanding Mortgage Principle."   Be sure to keep a record of your calculations with your tax paperwork.