Moved in 2023 (sold and bought house): Itemized mortgage interest not correct

[enfinityTX]

Hi: Let me first give the details of the tax situation and then how TT mishandles it:

1) Details:
- We sold a house in May 2023 (mortgage balance of 335K paid off in May) -- call this House A

- We bought a house in May 2023 (mortgage is 610K) -- call this House B

- Total interest on House A: 4K from Jan - May

- Total interest on House B: 20K from May - Dec (Two 1098 issued since mortgage lender sold loan to a bank)

- Total points for House B: 2K (This was on the 1098 of the original mortgage lender)

Since the mortgage balance in any given month was never over 750K, I assume all interest and points should be transferred to Schedule A. Is this understanding correct?

2) TT mishandles it

However, it seems like TT sums the principal balance for House A and House B, leading to an incorrect principal amount exceeding 750K. It also ignores the points on the first 1098 from the original lender. The resulting refund is smaller than it should be.

My workaround: On the screen "Your mortgage interest is being limited", TT informs me that it may be wrong. I then enter the full amount of mortgage interest for House A and B as well as the points for House B into the field "Your adjustments", which fills Schedule A correctly (success!). Is there anything I can do to get TT to get it right or is using my workaround the best strategy?

Thanks!

[zomboo]

Turbo Tax is not mishandling the mortgage interest deduction. It is following the averaging guidelines in Pub 936 for two loans each secured by a different main home. For example, a main and second home. This would give you an average balance for both loans of $935,000 which limits your deductible balance to $750,000. $750,000/$935,000 = 80.2% of your interest is deductible. Is this fair? Nope. Does it make sense? Nope.

Publication 936 does not address the situation where your main home is sold and a new main home is bought in the same year. This leaves you only with the option to use the averaging method used for keeping your main home and buying a second home.

If I were you, I would enter all of your interest as deductible when given the opportunity with the following adjustment. Since you can only have one main home at a time, you should deduct the interest for May on mortgage A from the total interest.

[enfinityTX]

Thanks for the detailed response! This seems like a fairly substantial issue for taxpayers (given that selling and buying during the tax year is a fairly common event -- and TT potentially follows Pub 936 to a fault).

I had an additional thought after re-reading Pup 936 in more detail:

Pub 936 states that "You have to figure the average balance of each mortgage" (page 12). I read this as I have to fill out Table 1 (page 11) for each mortgage -- this would make intuitive sense since during no months in 2023 did I have a mortgage balance in excess of 750K. 

Could this do the trick? I LOVE tax season 🙂

Thanks!

[zomboo]

Technically no, this is not what the instructions for Table 1 say. You don't run through the table for each mortgage, get the deductible interest for each one separately, and then add the individual interest amounts together. You figure the average acquisition balance and average total balance for each mortgage (if you only used the borrowed funds on your home, are the same value) and then add up the average values and run through the table once with theses averages.

However, we both believe you are entitled to deduct all of the interest paid between both homes in 2023. You just need to be able to explain how you calculated the amount of interest you claimed. The fairest way I have been suggesting is to amortize the average balance over 12 months. For each loan total up monthly balance for Jan through Dec, with 0 for the months the loan was not held and divide by 12. To be even fairer, zero out the balance and interest for the sold home mortgage in the months the loans overlap.

This method applies to refinances or when you take out a HELOC or when you have a mixed-use mortgage. So why does it not apply when you sell and buy a new home in the same year? Because in the case of a refinance or second mortgage, both loans are secured by the same main home and that home remained your main home all year. In the sell/buy case, you have two different homes securing the loans and neither was you main home for all 12 twelve months.