Taxes on money returned form the bank from overpaid mortgage, after lawsuit.

[BogeyS]

Hello,

I need some advice on the tax situation I have never experienced before.

I received the payment from the bank last year, which consisted of a return of overpaid mortgage and statutory interest for the late payment of the amount they held in their account. It was the result of the lengthy lawsuit, so the interest is quite substantial. I have also incurred lawyer expenses in considerable amounts. Plus, I probably have to return any mortgage interest which I have deducted on this property, is that correct?

I also have received some amount for the overpaid principal, which i assume is not taxable.

On the top of that I need to add, that it has happened in Poland, where I currently live. All these payments I have received from the bank are not taxable in Poland, as they are returned wrongfully collected money. I don’t know if it has any impact that it has happened overseas.

 My questions are:

1. Is the statutory interest I have received taxable?
2. And if yes, can I deduct the cost of the lawsuit as the interest expenses incurred for this income?
3. Do I have to return all mortgage interest which I have deducted on this property in prior years?
4. Is the refunded overpaid principal taxable?

I appreciate your advice.

[IsabellaG]

The taxability of your payment depends on the Tax Benefit Rule. See this link to the IRS Publication 525, under Recoveries. The rule says that if you receive a recovery of an amount that you deducted in a prior year, it is taxable to the extent that you received a tax benefit. 

In that same link, under Itemized Deduction Recoveries, there is a discussion of how to determine how much, if any, of the recovered interest is taxable.

To address your numbered questions:

1. If you mean that you were paid interest on top of the recovery of the mortgage interest and principal , then yes, it would be taxable.
2. In general, you can't deduct personal legal fees on your 2024 return. Legal expenses for a business are deductible, as well as expenses specifically related to adopting a child, whistleblower claims and unlawful discrimination claims. See this TurboTax article. 
3. As I explained above, interest that you recovered may be taxable according to the tax benefit rule.
4. No, the refunded principal is not taxable to you.
    

[BogeyS]

Hello Isabella,

Thank you very much for your clarification. I'm sorry for a delayed reply, but I just came back from a long trip, and I want to conclude my tax report.

It is clear for me now. I know I need to report interest income and refunded mortgage interest, and I can't deduct lawyers' expenses, sadly. I have found both income numbers, but I have next question. How to report it in Turbo Tax. I can't see the option to enter interest without an INT-99 form. And I don't see a form to enter recovered mortgage interest.

Could you please advise how to center it?

Thank you so much for your help.

Piotr Slodownik

[Vanessa A · Accepted solution]

You will enter the interest in the same place you would even if you didn't have a 1099-INT.

You can enter it by selecting the following:

1. Federal
2. Income
3. Show more next to Interest and Dividends
4. Start next to interest on 1099-INT

The mortgage interest would be added as Other Income. Since it was previously deducted from your income, you will just add it back to your income.

1. Federal
2. Income and Expenses
3. Scroll down to Less Common Income and click Show More
4. Start next to Miscellaneous Income
5. Start next to Other Reportable Income