I'm helping a friend with two houses understand the mortgage interest deduction limit and she raised a good point on calculating average mortgage balances according to the IRS rules in Pub 936. Let's say each house is secured by a $600,000 mortgage and the interest for the year is $20,000 on each. If they are owned all 12 months, the total interest is $40,000, but only $33,333 is deductible because the total mortgage of $1.2 million is over the $1 million limit. Fine if you bought the second home in January of the tax year. But let's say you buy it in December and only have 1 month of interest, say $1667. According to the IRS, the average mortgage balance is still $600,000 on each, but now the limit imposes a deductible amount of $18055 ($21,667/1.2). If she has waited until January 1 of the next year to close, she could have deducted the full $20,000 on the first home. That just seems wrong to be penalized like that. Is this just a quirk in the regulations?
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You need to calculate the average balance of each loan to determine the aggregate average balance of the 2 loans. This average will determine whether the total mortgage balance is above the limit of $1 million. You do not add up the full balance for the full year.
I found this question because I also found the publication 936 confusing, and the answer here helped me, yay!
@Prof-X At least in the 2019 publication, the flowchart just says to go to Part II to determine the limits. Filling out Part II sometimes gives the result that you can deduct all the interest. So I think the flowchart is just a rough check to see if you need to bother to do a more detailed determination of interest deductibility. I agree there are some pretty confusing parts in pub 936 though. Did the IRS complain about your friend's return?
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