Mortgage interest deduction: phrasing of "... and the loan amount has not increased due to a cash out refinance."

[Taco3]

This question in the mortgage interest deduction section seems a little ambiguously worded:

"""

Do either of these apply to this loan?

We’re asking because you might qualify for a bigger mortgage deduction if either is true.

• The original loan was taken out on or before December 15, 2017 and the loan amount has not increased due to a cash out refinance.
• The home purchase started on or after December 15, 2017, was scheduled to close before January 1, 2018, and closed before April 1, 2018, and the loan amount has not increased due to a cash out refinance.

"""

The ending of "and the loan amount has not increased due to a cash out refinance" in each statement could be interpreted in two ways:

1. We got a cash out refinance, but the loan amount didn't increase.
2. The loan amount did not increase -- for any reason at all, including cash out refinancing.

In our case, we have a mortgage from prior to 2017, and nothing about the loan has changed -- no refinancing of any kind. I assume this is talking about IRS Publication 936, and that yes, the higher limit of $1 million instead of $750k does apply to us. But the bit about specifically mentioning cash out refinancing makes me hesitate and think that maybe it doesn't apply to us because we didn't do a cash out refinance, and so the whole question is void.

[RaifH · Accepted solution]

You are correct, this is in reference to the home acquisition debt limits stated in IRS Publication 936. I would use your first interpretation of the and the loan amount has not increased due to a cash out refinance. 

While the wording is a little vague, what it is getting at is if you re-financed and the loan amount increased due to taking cash out for any reason not related to your home you would answer No. If your loan amount has gone down in the re-finance or it went up because you pulled money out to substantially improve your home which includes repairs to keep your home in good condition then you would answer Yes.

In your case, if your current mortgage is from 2017 or earlier, I'm a little surprised it is asking you this at all. But you would answer Yes and be grandfathered to when the debt limit was $1 million for your home. 

[sriramr]

But if I answer "Yes" my tax due goes up and if I answer "No" it goes down. Based on your explanation, I would expect the opposite.

Not sure why the tax due would go up if I refinanced with no cash out but will go down if I did. Something seems wrong here.

[RaifH]

Enter the loan in this manner if it is a refinance of a loan from before December 15, 2017. TurboTax will correctly apply the $1 million mortgage interest limit and allow the correct amount of interest as an itemized deduction:

1. In the Federal > Deductions & Credits section of your return, scroll down to Your Home and click Revisit/Start next to Mortgage Interest and Refinancing (Form 1098)
2. Edit your existing 1098. For
3. Answer the questions and enter the information from your Form 1098s. For Box 3 Mortgage Origination Date - Use the original purchase date back of your home. 
4. Answer What kind of property is this loan secured by?
5. Answer We didn't pay any points.
6. Answer Yes to Let's see if this is the most recent form for this loan.
7. Answer No to Is this the original loan used to buy your property? 
8. Answer Yes to Is this loan a HELOC or a refinance? 
9. Answer No to Did you take cash out? (assuming you did not take cash out when you refinanced in 2020)
10. Once you are back in the Home loan deduction summary screen, click Done.
11. Answer NO to Do either of these apply to this loan?
12. Enter the outstanding loan balance on January 1, 2022 in the first field. Leave the second field blank.

Pay particular attention to steps 3 and 11. This will calculate your deductible interest correctly based on the $1 million limit. Although not every answer is consistent with your loan, all the forms reported to the IRS will be accurate. 

@sriramr

[gullfoss]

I just ran into this exact same issue. Answering "No" to the "Do either of these..." question does indeed cause my mortgage interest deduction to be applied, as expected. However, based on the wording of the questions, I think that, I too, should answer Yes. However, that causes there to be no interest deduction.

This just seems like a bug, or a very poorly worded question. I worry that an update to the software will reverse things and cause my interest not to be deducted. I guess I'll re-check before filing.

RaifH, I appreciate your help, but when you have to answer with, "Although not every answer is consistent with your loan, all the forms reported to the IRS will be accurate," then it sure seems like we're having to work around buggy software.