IRS Pub 936: Mortgage Interest Limit

Non-investing personal finance issues including insurance, credit, real estate, taxes, employment and legal issues such as trusts and wills.
Post Reply
Topic Author
pancake19
Posts: 133
Joined: Thu Jan 16, 2014 12:46 pm

IRS Pub 936: Mortgage Interest Limit

Post by pancake19 »

Hi all,

I'm having trouble finding advice / explanations of this even though it seems like a fairly common situation.

I purchased my first home in 2022, for the sake of simplicity let's call it $1M mortgage on July 1. I understand the IRS limits my interest deduction to the first $750K of mortgage.

However Publication 936 states the 750K is compared to the average mortgage balance during the past year. Turbotax wants me to assume the 1/1/22 balance is $1M and then uses my actual 12/31/22 balance of $900K, and then says the average is therefore $950K.

When I read Pub 936, this is the first method to calculate the average. However the second method is to take the interest I have paid during the year and divide it by the interest rate. Obviously because I only originated this mortgage in the middle of the year, the second method results in a significantly lower average balance. In fact the average is below the $750K.

Am I permitted to use the average interest method? For whatever reason the Pub 936 does not seem to address intra-year origination at all, unless I'm just missing it...
User avatar
HueyLD
Posts: 9789
Joined: Mon Jan 14, 2008 9:30 am

Re: IRS Pub 936: Mortgage Interest Limit

Post by HueyLD »

pancake19 wrote: Sun Jan 29, 2023 2:20 pm Hi all,

I'm having trouble finding advice / explanations of this even though it seems like a fairly common situation.

I purchased my first home in 2022, for the sake of simplicity let's call it $1M mortgage on July 1. I understand the IRS limits my interest deduction to the first $750K of mortgage.

However Publication 936 states the 750K is compared to the average mortgage balance during the past year. Turbotax wants me to assume the 1/1/22 balance is $1M and then uses my actual 12/31/22 balance of $900K, and then says the average is therefore $950K.

When I read Pub 936, this is the first method to calculate the average. However the second method is to take the interest I have paid during the year and divide it by the interest rate. Obviously because I only originated this mortgage in the middle of the year, the second method results in a significantly lower average balance. In fact the average is below the $750K.

Am I permitted to use the average interest method? For whatever reason the Pub 936 does not seem to address intra-year origination at all, unless I'm just missing it...
The intra-year origination is actually address in the pub.

“ Interest paid divided by interest rate method.

You can use this method if at all times in 2022 the mortgage was secured by your qualified home and the interest was paid at least monthly.”
Topic Author
pancake19
Posts: 133
Joined: Thu Jan 16, 2014 12:46 pm

Re: IRS Pub 936: Mortgage Interest Limit

Post by pancake19 »

i'm not trying to be difficult but i truly am trying to figure out whether the instructions allow me to call my average balance for the year in my example something like 500k or is it 950k.

i see your point re: interest rate method, that's not how i originally read it but i think your reading is more correct.

however for example look at the monthly statement method following your same logic.
"You can treat the balance as zero for any month the mortgage wasn't secured by your qualified home"

so then in my example it's (0+0+0+0+0+0+1M+0.99+0.98+0.97+0.96+0.95) / 12 = approx 0.5M?
User avatar
HueyLD
Posts: 9789
Joined: Mon Jan 14, 2008 9:30 am

Re: IRS Pub 936: Mortgage Interest Limit

Post by HueyLD »

I think you need to read further into the example.

“ If you receive monthly statements showing the closing balance or the average balance for the month, you can use either to figure your average balance for the year. You can treat the balance as zero for any month the mortgage wasn't secured by your qualified home. For each mortgage, figure your average balance by adding your monthly closing or average balances and dividing that total by the number of months the home secured by that mortgage was a qualified home during the year.”

So, your denominator should be “6.”

That’s my reading of the pub. It is your taxes and you can do what you believe is the right way.

Good luck.
Topic Author
pancake19
Posts: 133
Joined: Thu Jan 16, 2014 12:46 pm

Re: IRS Pub 936: Mortgage Interest Limit

Post by pancake19 »

d'oh you're right, thanks
bmsuter
Posts: 31
Joined: Thu Jan 01, 2015 2:48 pm

Re: IRS Pub 936: Mortgage Interest Limit

Post by bmsuter »

pancake19 wrote: Sun Jan 29, 2023 7:23 pm i'm not trying to be difficult but i truly am trying to figure out whether the instructions allow me to call my average balance for the year in my example something like 500k or is it 950k.

i see your point re: interest rate method, that's not how i originally read it but i think your reading is more correct.

however for example look at the monthly statement method following your same logic.
"You can treat the balance as zero for any month the mortgage wasn't secured by your qualified home"

so then in my example it's (0+0+0+0+0+0+1M+0.99+0.98+0.97+0.96+0.95) / 12 = approx 0.5M?
If you read the publication, it specifically says you can't deduct all of your interest if your mortgage is over 750k. By using your logic above, you are basically saying your average balance is 500k, when you know your mortgage is really over 750k. Your logic would not work in an audit and you would end up owing the difference in the deduction plus a fine.

The way I've been doing it, which is part of the publication, is that I take the statement balance for each month as the balance for the month and then average them. In your case, it would be dividing the balances by six or seven months or however many months your mortgage has been active. It looks like you're paying down principal early and I think this is the best way to do it in that scenario at least from what I've read.
czarmar
Posts: 2
Joined: Tue Nov 01, 2022 6:56 am

Re: IRS Pub 936: Mortgage Interest Limit

Post by czarmar »

I'm in a similar situation - I have an existing house with ~$275K 3% mortgage. In August 2023, I bought and moved into a new house with a $725K 6% mortgage. I moved into the new house the same day we closed. I can think of some pathologically bad and illogical ways to calculate my mortgage interest deduction limit, but what I'm thinking is that my old house has become non-qualified because we moved out without intending to keep it as a 2nd house, instead it is listed for sale.

What I'd like to do and it seems to make sense is to deduct the interest paid from my old home during the time I lived in it, and not after I moved to the new house, for which the mortgage here remains under the limit, and deduct all the interest paid for the new house.

Looking over the Pub 936 which doesn't cover a lot of common situations where someone owns a house for part of the year, it seems that there's a number of ways to calculate it.
1. average loan balance is well under the limit for the entire year, deduct all interest paid for both houses
2. sum the two loans in spite of the larger loan and home held for a short time 280K + $725K = $1.005M = ~75% of loans are deductible
a. Claim lower rate loan interest first for 12 months, then I can deduct 4 months of higher rate loan balance (750-275 = 475 deductible from big loan) 475/725 = 65% of higher rate interest paid deducted. Pathologically bad because the bigger loan is at a higher rate.
b. Claim lower rate loan for old house for 8 months, then claim new primary loan balance at higher rate for 4 months, leaving 25K of deductibility for the last 4 months for the old house
3. The most reasonable solution is to not take any deduction for the old loan for time after we moved out intending to sell it. It would seem that in all cases, we'd be under the limit and can fully deduct our new home's mortgage interest.

Of course to add fuel to the fire, there was a recent tax court case involving the IRS reducing the deductibility of interest paid on a property that was sold during the year because the balance of the loan was averaged over the year reducing the average balance under the limit rather than over the period the property was held, during which the loan balance exceeded the then threshold of $1M. I don't really understand the ramifications of all this, and we've got poor guidance from the IRS.
https://www.parkertaxpublishing.com/pub ... tiona.html
Post Reply