By Jack Jerue One of the most appealing aspects of real estate investing is the…
When filing tax returns, many homeowners choose to itemize their deductions because of the mortgage interest deduction. But because of increased fraud, there are two new mortgage interest reporting requirements designed to catch false or inflated deductions.
Mortgage interest generally includes interest paid or accrued during the tax year on debt secured by either the taxpayer’s principal residence or a second home to the extent it is considered to be used as a residence (a “qualified residence”).
Qualified residence interest is subject to several dollar limitations:
- The total acquisition indebtedness (principal) on which qualified residence interest is deductible is limited to $1 million ($500,000 in the case of married individuals filing separately).
- The total amount of home equity indebtedness (principal) taken into account in calculating deductible qualified residence interest may not exceed $100,000 ($50,000 in the case of married individuals filing separately).
The IRS Form 1098 has been revamped
In the past, mortgage service providers were required to report only limited information on the IRS 1098 form, specifically:
- the name and address of the borrower;
- the amount of interest received for the calendar year of the report; and
- the amount of points received for the calendar year and whether the points were paid directly by the borrower.
On July 31, 2015, the 2015 Surface Transportation Act (aka the Highway bill) was signed into law. Included in the Act was a change to the information that loan servicers are required to report on the IRS Form 1098, specifically adding:
- the amount of outstanding principal of the mortgage as of the beginning of the calendar year,
- the address of the property securing the mortgage, and
- the loan origination date.
Note that these above mentioned items are in addition to the information that was already required to be provided to the IRS and payors under existing law.
Additional Compliance Periods
Because this modification imposes a significant new burden on mortgage service providers, the IRS is allowing mortgage service providers additional time to reprogram their systems. Implementation will be in the 2016 tax year, meaning that the additional reporting requirements apply to returns filed after December 31, 2016. Simply stated, the current reporting method will be allowed for the 2015 tax year, but the 2016 tax year will have the new requirement imposed.
New Ruling on Mortgage Deductibility for Joint Ownership
A recent legal ruling effectively doubles the size of the mortgage interest deduction available to joint homeowners.
In reversing the Tax Court, a panel of the Court of Appeals for the Ninth Circuit found that when multiple unmarried taxpayers co-own a qualifying residence, the debt limit provisions apply per taxpayer and not per residence (Voss, CA-9, August 7, 2015).
The subject taxpayers are registered domestic partners who obtained a mortgage to purchase a house in Rancho Mirage, California. In 2002, the taxpayers refinanced and obtained a new mortgage on the property. That same year, the taxpayers purchased another house in Beverly Hills, California with a mortgage, which they subsequently refinanced and obtained a home equity line of credit totaling $300,000. The total average balance of the two mortgages plus the line of credit was approximately $2.7 million. Both taxpayers filed separate income tax returns and each individual claimed home mortgage interest deductions for interest paid on the two mortgages and the home equity line of credit.
The IRS calculated each taxpayer’s mortgage interest deduction by applying a limitation ratio to the total amount of mortgage interest that each petitioner paid in each taxable year. The limitation ratio was the same for both: $1.1 million ($1 million of home acquisition debt plus $100,000 of home equity debt). The taxpayers challenged the IRS’s calculations, but the Tax Court ruled in favor of the agency.
The Court of Appeals, however, found that interest on a qualified residence, by a special carve-out, is not considered “personal interest,” which would otherwise be nondeductible by taxpayers who are not corporations. The Appellate Court further found the Tax Code limits the aggregate amount treated as acquisition indebtedness for any period to $1 million and the aggregate amount treated as home equity indebtedness for any period to $100,000. In the case of a married individual filing a separate return, the debt limits are reduced to $500,000 and $50,000.
Looking at the language of the Tax code, the court found that the debt limit provisions apply per taxpayer and not per residence and further concluded there was no reason not to extend this treatment to unmarried co-owners, meaning, each of the homeowners was entitled to the $1 million limit.
As always, it is important to check with your legal counsel and tax advisor regularly to discuss changes in the laws.
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