IMPLEMENTING THE POSSIBLE NEW MORTGAGE DEDUCTION RULES

The House passed tax bill – the Tax Cuts and Jobs Act - is NOT as great as the Republicans say it is, and it is NOT as disastrous as the Democrats say it is.

It is a mixed bag – with good, bad, and ugly.  It has some simplification, and also adds unnecessarily to the complication of the Tax Code.

It is most certainly NOT a “massive tax cut for the middle class”.  And arrogant idiot Donald T Rump and his family benefit substantially from its provisions.

Whatever tax legislation is finally signed into law, if one is indeed finally signed into law – it will not deal with the practical implementation of the provisions of the Act.  The idiots in Congress rarely, if ever, take this into consideration when writing tax law.  It will be up to the Internal Revenue Service to establish the rules and regulations for implementation, up to the taxpayer and tax preparer to properly comply, and back to the IRS to verify compliance.

Let us look, for example, at the deduction for mortgage interest.

As I understand it, in the House bill existing mortgage debt is “grandfathered”, keeping the current rules for deduction.  For all new mortgage debt incurred after November 2^nd, or perhaps the date of enactment, the deduction will be limited to interest on principle of up to $500,000 of acquisition debt only for a taxpayer’s one primary personal residence.  Interest on new home equity borrowing will no longer be deductible.  I am assuming that additional borrowing for the “substantial improvement” of the primary personal residence will continue to be classified as acquisition debt.

The Senate’s final version keeps the mortgage interest deduction intact (but it does do away completely with all state and local taxes – income, sales personal property, and real estate).

Currently the Form 1098 (Mortgage Interest Statement) – which the IRS matches to deductions for mortgage interest claimed on Schedule A - reports the total amount of all “mortgage interest received from borrowed”, as well as “points paid on purchase of principal residence”.  It also indicates the outstanding mortgage principle balance at the beginning of the year, for example 1/1/2017, but does not break down the specific amount of acquisition debt or home equity debt. 

The taxpayer is currently responsible for keeping separate track of acquisition and home equity debt – something I truly believe probably 90% of taxpayers do not do, or do not do properly.  And, I expect, a similarly substantial percentage of tax preparers do not keep separate track of debt for their clients.  If the House provision survives the conference committee and makes it into the final law, and no change is made to the current Form 1098, it will be more important than ever for taxpayers to keep separate track of acquisition debt and home equity debt.

A new Form 1098 should be created to separately report –

1. Total mortgage interest received for the year on all “grandfathered” mortgage debt.

2. Year-beginning principle balance of all “grandfathered” mortgage debt.

3. Total mortgage interest received for the year on “new” acquisition debt on the purchase of, and capital improvement to, the mortgagee’s primary personal residence on up to $500,000 in principle.

4. Points paid on the first $500,000 of principle on the purchase of a primary personal residence.

The form would not report any “new” home equity debt interest.

Mortgage lenders should be required to identify the purpose of the borrowing – acquisition debt or home equity debt – via taxpayer certification, and keep separate internal track of the two types of debt.  Perhaps mortgage lenders should create two separate debt instruments and not combine acquisition and home equity debt in the same loan.  Going forward, for simplicity sake, the closing costs on the refinancing of “new” acquisition debt, where the borrower does not take additional money for anything other than capital improvements to the residence, should be included in acquisition debt.  

Obviously, this would create more work for mortgage lenders.  But it would greatly improve compliance and make the job of the IRS, and the tax preparer, much easier.  Mortgage lenders would have a full year from final passage of the Act to change their internal accounting systems.

As an aside – one question I have is whether new refinancing of grandfathered debt would be treated as continued grandfathered debt, and deductible under current rules, or as new mortgage debt, and subject to the new limitations.

And as a further aside - I totally support the new treatment of the deduction of mortgage interest as it exists in the recently passed House version of the Act.  I would actually go further and limit “grandfathered” debt to mortgages only on a taxpayer’s one primary personal residence – I would no longer allow any itemized deduction for a second or vacation home. 

There will certainly be implementation issues with other provisions of any final act that will need to be, hopefully, intelligently dealt with.

So, what do you think?

TTFN