DEDUCTING MORTGAGE INTEREST - UNMARRIED CO-OWNERS

Here is a real-life tax situation I was recently asked about -

A retired taxpayer lives in South Carolina and his adult son lives and works in California. The son wants to purchase a personal residence in California worth $1.3 Million but needs the help of his father with both the down-payment on the property and the monthly mortgage payments. The purchase mortgage principal will be $1.1 Million. Title to the residence will be held in the name of the son and the father jointly and both will be named on the purchase mortgage – but only the son will actually live in the property. The property will be the primary personal residence of the son – but not the father. The son will pay 75% of the monthly mortgage payment and the father will pay 25%.

I was asked to answer two questions -

(1) Can the California property be considered a “qualified second residence” of the father for purposes of deducting acquisition debt mortgage interest on his Schedule A or is it treated as an “investment property” with the applicable mortgage interest deducted by the father as investment interest, subject to the investment income limitation? 

(2) If the property is considered a qualified second residence of the father how much of the interest paid by the father can he deduct on Schedule A.

Taxpayers who itemize on Schedule A can deduct interest paid on “acquisition debt” - debt used to buy, build, or substantially improve a main residence or a qualified second home. A “substantial improvement” is one that adds value to the home, prolongs the home’s useful life, or adapts the home to new uses.

In order to qualify for the deduction -

* The home must be the owner’s personal residence (primary or secondary).

* The home must be used as the security for the loan.

* If the homeowner defaults on the loan the home will be taken to “satisfy” the debt.

* The loan must be recorded with the appropriate agency under state law, usually at the county level.

Qualified residence interest can only be deducted if you have an ownership interest in the home, you are legally obligated to pay the mortgage debt, and you actually make payments on the debt.

When two people buy a home together, and both owners are named on the mortgage, each owner can deduct the amount of interest he or she actually pays. If you pay 25% of the mortgage payment you can deduct 25% of the interest.   If you pay 50% of the mortgage payment you can deduct 50% of the interest.  If you own a home with a partner, but pay the entire mortgage payment each month you can deduct 100% of the mortgage interest on your Schedule A.

For mortgage loans on new home purchases incurred after December 15, 2017, you can deduct the interest on up to $750,000 in principal ($375,000 if Married Filing Separately).  Qualified debt cannot exceed the cost of the home and any substantial improvements. 

The principal limitation applies to unmarried co-owners of a qualified residence on a per-taxpayer basis and not a per property basis.   Each individual unmarried co-owner can deduct mortgage interest on up to $750,000 (or $1 Million) of acquisition debt.  So, an unmarried couple who jointly purchase a property in 2022 with a mortgage of $1,500,000 can each deduct 50% of the total interest paid on the property, assuming they each pay half of the monthly mortgage payment, and even though the loan principal exceeds $750,000.      

Also deductible on Schedule A is “investment interest” - interest that is paid on loan proceeds used to purchase taxable investments or securities.  Real estate is an investment.  The deduction is limited to the taxpayer’s “net investment income” – taxable interest, “non-qualified” dividends, net short-term capital gains, royalties, and annuities less deductible investment expense (obviously not including investment interest).  Qualified dividends and long-term capital gains can be included in investment income if the taxpayer elects not to tax this income at the special lower capital gain rates.  Excess investment interest (investment interest paid that is not deductible on the current return) can be carried forward and deducted on future returns, subject to the net investment income exclusion.

In our scenario the father is not charging his son any fair market rent for his ownership interest, so the father is considered to be using the home for personal purposes and it can be treated as a qualified second home of the father for purposes of claiming a mortgage interest deduction.

And since the principal limitation if per taxpayer and not per property, and the father is named on the mortgage, the father can deduct the full amount of mortgage interest he pays.  If the total interest for the year is $10,000 and the father paid 25% of each monthly mortgage payment paid from his funds, he can deduct $2,500 as mortgage interest on his Schedule A.

I have written a special report on “Deducting Mortgage Interest” that discusses in detail all the rules and regulations for the Schedule A mortgage interest deduction.  It emphasizes the vital importance of keeping separate track of “acquisition debt” and “home equity debt” and provides a detailed example and worksheets for you to use.  The cost is only $2.00.

It is my firm belief that more often than not taxpayers who itemize are deducting the wrong amount of mortgage interest – either too much or too little.  Every single homeowner with a mortgage who itemizes on their federal tax return needs to purchase and read this report.

To order your copy of this report send a check or money order for $2.00 – payable to Taxes and Accounting, Inc – and a SASE to –

DEDUCTING MORTGAGE INTEREST
TAXES AND ACCOUNTING INC
POST OFFICE BOX A
HAWLEY PA 18428 

TTFN 

ANOTHER VERY VERY VERY VERY VERY VERY VERY IMPORTANT TOPIC

As a result of the GOP Tax Act, for tax years 2018 through 2025, or until new tax legislation is enacted, only mortgage interest on “acquisition debt” – money borrowed to buy, build or substantially improve the residence – is deductible on Schedule A.  Interest on home equity debt interest – money borrowed to buy a car, pay for college, pay down credit card interest, etc. – is not deductible, regardless of the amount.  Period.  And there is no grandfathering of existing home equity debt.

It has always been important for homeowners to keep separate track of acquisition debt and home equity debt, because of the previous $100,000 principal limitation on the deduction for home equity interest and the fact that home equity debt interest was not deductible in calculating the dreaded Alternative Minimum Tax.  However, I do not know of a single homeowner who actually did this.  Even before the hastily written GOP Tax Act was scribblings on a cocktail napkin I had commented that the deduction for mortgage interest, both on Schedule A and Form 6251, was perhaps the area of the Tax Code where proper documentation and strict adherence to the law was the most overlooked (or actually ignored).    

But if the dreaded AMT was not a consideration this wasn’t an issue in most cases because of the $100,000 home equity principal threshold.  Now it is truly vital that his be done, going back to the original purchase mortgage for the property.

I explained this in detail to applicable 1040 clients last tax season when giving them their finished 2017 tax returns.  And I gave these clients worksheets with instructions and a detailed example to use to track the two different types of debt and offered to track the debt for them during the year at a slightly reduced hourly rate.

Nobody contacted me during the year to ask me to do it for them.  And this past tax filing season every single client either (1) assumed that they could not itemize, because I told them so last year and it didn’t matter, or (2) totally ignored the need to differentiate between acquisition debt and home equity debt and, like every other year, merely gave me their 1098s and expected me to either intuitively know the correct amount to claim or pull a number out of the air.

The one good thing about dealing with this issue during the tax filing season is that most clients who consistently itemized in the past can no longer itemize, regardless of the amount of mortgage interest paid, so it did not matter that they did not properly identify the correct amount of deductible interest.

Over the years most homeowners have refinanced their mortgage, often several times, for a variety of reasons, taken out home equity loans or lines of credits, also for a variety of reasons, and consolidated mortgage and equity loans.  In NJ, where most of my clients live, the market value of homes was excessively inflated at various times, creating the potential for additional borrowing.  There were many instances when a homeowner’s mortgage principal exceeded the original purchase price of the property and the cost of subsequent capital improvements.  Unless the homeowner purchased a new home recently, most, if not all, current mortgages include some combination of acquisition debt and home equity debt.

It is the responsibility of the taxpayer, and NOT the tax preparer, to separately track acquisition and home equity debt and properly identify the correct amount of deductible acquisition debt interest.  You can ask your tax pro to do this, or he or she may actually have been doing this on his or her own, but never assume or expect that he or she has been doing it. 

And it is the responsibility of the taxpayer to provide documentation for the amount of mortgage interest deducted if questions by the IRS.

Two important points to know when tracking the debt -

(1) Thankfully, to simply the tracking process, when applying principal payments to the different type of debt in mixed-use mortgages you first reduce home equity debt and any debt you have identified as investment debt.  Acquisition debt is paid down last.

(2) When a homeowner refinances, only that portion of the principal of the new loan that represents the pay-off of the principal on the original mortgage, if it is all acquisition debt, continues to be acquisition debt.  Any closing costs for a refinance that are included in the principal of the new loan is home equity debt.

The first step to determine the amount of current acquisition debt is to go back to the Closing or Settlement Statement for the very first refinance.  Look at the amount of principal of the original mortgage that was paid off in the refinance.  Compare this number to the 1/1/2018 principal balance reported on the Form 1098 for the current mortgage. 

If the pay-off of the initial mortgage is $100,000 and the 1/1/18 principal balance is 150,000 you then need to determine if any of the additional $50,000 was used to pay for capital improvements to the property.  If not, multiply the $100,000 by the rate of interest you are paying on the current mortgage.  If the rate is 3.5% than the Schedule A deduction is $3,500.

If the 1/1/2018 principal balance is $98,500 than all of the interest paid in 2018, and reported on the Form 1098, is fully deductible acquisition debt interest.

Of course, this example assumes you still have the Closing or Settlement Statement for that first refinance.  In discussing how long a taxpayer should keep records I recommend “if you own real estate keep all Closing or Settlement Statements for the purchase and refinancing of the property, and documentation of any capital improvements, for as long as you own the property plus four additional years”. 

For new homeowners going forward, if the limitation of the mortgage interest deduction to acquisition debt interest continues, and I personally believe it should despite the added complication -

(1) If you need to borrow money for home improvements open a separate home equity loan or line of credit and use this ONLY for home improvements that qualify as acquisition debt.  And keep documentation of the improvements. 

(2) If you need to borrow money for anything else - to pay down personal debt, pay for college, buy a car, etc - open a separate home equity loan or line of credit and use this ONLY for non-acquisition purposes.

(3) Never consolidate or combine the three mortgage accounts.  And if you refinance, always pay the closing costs in full with cash, or money from the non-acquisition home equity line of credit, and ONLY refinance the existing principal balance of the original mortgage.

So, homeowners who may still be able to itemize – read and understand this post carefully and either pay your tax professional to separately track your debt before the end of 2019 (and NOT during the 2020 filing season) or do it yourself. 

If you are going to do it yourself and want my worksheets and detailed instructions for doing this order my MORTGAGE INTEREST GUIDE.

Any questions?

TTFN

DEALING WITH TAX MYTHS ABOUT THE GOP TAX ACT

My legitimate ongoing concern about the “urban tax myth” that CPAs are automatically 1040 tax exports by virtue of their initials (they are most certainly NOT) doesn’t mean that online CPA-related sources do not provide excellent and timely information and commentary on 1040 issues.

Case in point “Tax Reform Myths and Facts for 2019: What the TCJA Really Means for Taxpayers” by Dave Duval, EA (you will note that he is an EA and not a CPA) at CPA PRACTICE ADVISOR.

Dave makes some excellent points in his piece, beginning with – “As tax practitioners, we wear many hats: tax aficionado, document sorter, government form translator, timekeeper, empathetic ear, and counselor.”

The article deals with the “plethora of information (and more pointedly, misinformation) about the Tax Cuts and Jobs Act of 2017” that is out there.  

Here are some of the good “take-aways” from Dave’s discussion (highlights are mine) –

* State Income Taxes: “Depending on the state, there may be full conformity {with the GOP Tax Act} or none at all. For example, in California taxpayers will still be able to deduct unreimbursed employee business expenses that are over 2% of their federal adjusted gross income. It will be crucial communicating to our clients that states may or may not have conformed to the federal changes, and it is still important to continue to retain documentation on certain deductions that may have been eliminated at the federal level but still apply at the state level. Retaining the documentation may result in lower state taxes, thereby easing the sting of losing the deductions on the federal return.”

NJ residents can still deduct out of pocket medical expenses, including some expenses that may be “pre-tax” for federal tax purposes but not for NJ state taxes, in excess of 2% of NJ Gross Income whether or not they itemize on the federal return.  And PA residents are able to deduct most employee business expenses without any income limitation.

* Alimony: The changes to the rules for reporting and deducting alimony “is only true for divorce or separation instruments executed on or after January 1, 2019. Alimony that is paid pursuant to a divorce or separation agreement executed before January 1, 2019, will still adhere to the alimony rules in place before TCJA. Divorce or separation agreements that were in place before January 1, 2019, and are modified after December 31, 2018, will still follow the old alimony rules unless the modified agreement specifically states it now follows the new rules.”

* Home Equity Interest: “As tax practitioners, we may need to spend more time with our homeowner clients discussing the difference between acquisition and equity loans, and performing interest tracking on how the proceeds were used. Additionally, we may need to request additional paperwork from our clients, such as the loan documents, and hope they recall where they spent the money.”

It is the responsibility of the taxpayer, and not the tax preparer, to separately track acquisition debt and home equity debt.  The importance of doing this cannot be stressed strongly enough.  Taxpayers should begin to work on this task NOW.  Check out my “Mortgage Interest Guide”. 

* Section 199a Deduction: “Many small business taxpayers are anticipating a big tax break this year due to the new 20% qualified business income deduction. Those small businesses that are organized as C corporations may be wanting to switch to a sole proprietorship or S corporation in order to take advantage of the deduction as fast as possible. Hopefully, these taxpayers will be contacting us first and not an online legal site where they can make the switch themselves {very, very important – consult your tax professional before you do anything regarding a change of business entity – rdf}. Many small business owners are not aware of the limitations and complexities to this deduction. Furthermore, there may have been very important reasons why a business formed as a C corporation that goes beyond taxes. By switching entities, these reasons may fall by the wayside.”

The Section 199a deduction is ridiculous, and ridiculously complicated, and unnecessary.  More proof that the members of Congress are idiots.

* The New “Postcard” 1040: “Some taxpayers will be lulled into a false sense that this means taxes are now simpler, and therefore the fee to prepare the return will be lower. As we know, expensive things can come in small packages. With all the changes courtesy of TCJA and state nonconformity, this tax season may be one of the most complicated we have seen. As such, we will need to educate our clients on this and caution them that the preparation fee may be larger this year.”

The “postcard” 1040 is perhaps the stupidest idea I have seen in over 45 years of preparing tax returns. 

Dave’s bottom line truly tells it like it is –

“One thing is for certain about the upcoming tax season − just about every tax return is going to take extra time and care.”

Thanks to Dave for an excellent discussion that should be read by all taxpayers and tax preparers (not just CPAs).

TTFN

WE NEED A NEW FORM 1098 FOR MORTGAGE INTEREST

Home equity interest is no longer deductible as an itemized deduction on Schedule A.  Period.  There is no “grandfathering” of existing home equity debt.

Only interest paid on “acquisition debt” – a loan secured by your residence the proceeds of which are used to “buy, build or substantially improve” the property – can be deducted.

It does not matter what the lender calls the loan.  Interest on what a bank, credit union or mortgage company calls a “home equity loan” or “home equity line of credit” can be deducted if the proceeds of the borrowing is used to “substantially improve” the residence.

IRS Pub 936 tells us –

“An improvement is substantial if it:

Adds to the value of your home,

Prolongs your home's useful life, or

Adapts your home to new uses.

Repairs that maintain your home in good condition, such as repainting your home, aren't substantial improvements. However, if you paint your home as part of a renovation that substantially improves your qualified home, you can include the painting costs in the cost of the improvements.”

A lender will issue IRS information return Form 1098 “Mortgage Interest Statement” to report interest you pay on a loan secured by a home.  It is required to be issued if the interest paid for the year is at least $600.  This form reports mortgage interest received by the lender, the outstanding principal on the mortgage loan on the first day of the year (i.e. 1/1/2018), the origination date of the mortgage loan, and identifies the property that is used to secure the loan. 

You CANNOT just take the number reported as “mortgage interest received” in Box 1 of the Form 1098 and put this on Schedule A.  This form does not tell you whether the interest received is acquisition debt or home equity debt or a combination of the two.  This is because the lender does not necessarily know with certainty what you did with the money you borrowed.

There has always (or at least since October 13, 1987) been a difference between acquisition debt interest and home equity debt interest and limits on the amount of each type of interest deductible.  It has always been important to keep separate track of acquisition debt and home equity debt.  But it is now more important than ever to do this.

The IRS needs to change the Form 1098 and require mortgage lenders to provide additional information to help the taxpayer, tax professional and the Service itself in determining the correct amount of allowable itemized deduction. 

It would be truly great if the Form 1098 would separately report, with legal certainty, the amount of deductible acquisition interest received and the amount of non-deductible home equity interest received - but this would probably truly be impossible.     However, there is some information that a lender does have that should be included on the Form 1098.

The lender should be able to check a box on the Form 1098 to indicate if the loan is (1) an original acquisition mortgage (a loan used to purchase or build a residence) or (2) a refinance of an existing mortgage.  If the loan is an original acquisition mortgage it is obvious that 100% of the interest reported is eligible for a deduction, within the principal limitations.

When you refinance an existing 100% acquisition debt mortgage only the amount of principal on the loan being refinanced is considered acquisition debt.   The additional closing costs of each refinance that were added to the principal of the refinanced mortgage is home equity debt.  The only way you would avoid home equity debt in such a situation is if you literally refinanced only the principal from each old mortgage and paid all closing costs in cash.

John and Mary purchased a home in 2011.  They have one mortgage, from the original purchase, and no home equity debt.  They want to refinance their original mortgage in 2018 to get a better rate.  The principal balance on the original mortgage is $197,374.  The principal balance of the new mortgage will be $200,000.  They did not take any money “out” and paid a little over $1,000 at the closing.  The difference is the closing costs for title insurance, inspections, fees, etc. etc.  John and Mary now have acquisition debt of $197,374 and home equity debt of $2,626. 

If the loan covered by the Form 1098 is a refinance of an existing mortgage the lender should be required to indicate the principal balance of the loan being refinanced and the amount of closing costs paid by principal of the new loan.  In the above example, the 2018 Form 1098 would report $197,374 in the new box for principal balance refinance and $2,626 in the new box for financed closing costs.   

Do you have any suggestions of other information available to the lender that should be added to a revised Form 1098?   

The IRS has issued a draft 2018 Form 1098, and there appears to be no change to the form. 

Unfortunately, if the 1098-T is any indication, if the information reporting requirements of the Form 1098 for mortgage interest is revised it will be years before complete and accurate forms, properly reporting all the necessary additional information, will actually be issued.  By the time the requirements are all fully phased in the law change will have expired.

FYI, I have prepared a MORTGAGE INTEREST GUIDE with worksheets and instructions for keeping separate track of acquisition and home equity debt.

As usual, any thoughts?

TTFN 

THREE IMPORTANT TAKEAWAYS ON MORTGAGE INTEREST FROM THE GOP TAX ACT

The “Tax Cuts and Jobs Act” changed the rules for deducting mortgage interest.  Here are three important “take-aways” from the new rules.  I have discussed these take-aways in past posts here at TWTP - but they bear repeating.

(1) Home equity interest is no longer deductible. 

Home equity interest is interest on loans secured by a residence whose proceeds are NOT used to “buy, build or substantially improve” the property secured.  This includes both existing and new borrowings.  There is no “grandfathering” of existing home equity loan interest.

If you have refinanced your home or taken out a home equity loan or opened a home equity line of credit, or plan to do any of these in the future, to get money to pay down credit card debt, pay for your children’s college, buy a car, pay medical bills, etc., or increased your principal in refinancing to cover the closing costs of the new loan, the interest on this borrowing is NOT deductible if you itemize on Schedule A.

(2) Home equity debt is defined by the use of the money borrowed and not what the lender calls the loan. 

If you take out what the lender calls a “home equity loan” or open what the lender calls a “home equity line of credit” and use the money from the loan to pay for capital improvements to “substantially improve” your home this is acquisition debt and the interest is fully deductible on Schedule A, up to the statutory principal limits.

(3) Homeowners MUST keep separate track of acquisition debt and home equity debt.

This has always been important because of the previous $100,000 principal limit on the home equity interest deduction.  But now it is vital.  You must go back to your initial purchase mortgage and track all subsequent refinancing and new mortgage loans.

It is the responsibility of the taxpayer, and NOT your tax professional, to keep track of mortgage borrowing.  However, you certainly can ask, and pay, your tax professional to do this.  The time to ask is NOW – not during the tax filing season.

A bonus item.  In order for a loan to qualify for the mortgage interest deduction, these three conditions must be met –

* The home being bought, built or substantially improved must be used as the security for the loan.

* If the homeowner defaults on the loan the home will be taken to “satisfy” the debt.

* The loan must be recorded with the appropriate agency under state law.

This is not new.  It has been the law since the Tax Reform Act of 1986.  A mortgage loan with a bank or commercial lender will generally meet all of these requirements.  But it is very important that private mortgage loans, including those resulting from installment sales where the seller “takes back” the mortgage, be recorded with the appropriate government agency, usually the county recorder's office, in order to be able to deduct the interest paid.

Of course, these take-aways are only important if you are still able to itemize.  The combination of the increased Standard Deduction and the loss and limitation of allowable deductions will mean that many taxpayers who had consistently itemized in the past will no longer be able to do so. 

I discuss the new mortgage interest deduction in more detail in my book “The GOP Tax Act and the New 1040” and my “Mortgage Interest Guide”.  The Mortgage Interest Guide includes worksheets, with an example, you can use to track your mortgage debt.   

TTFN

SIMPLIFICATION AND COMPLEXITY FOR TAXPAYERS

While the GOP Tax Act adds much unnecessary complexity to the Tax Code, it does make some things simpler.

By eliminating the miscellaneous deductions subject to the 2% of AGI limitation, taxpayer recordkeeping is simplified.  Employees who are not reimbursed for their job-related expenses under an accountable plan will no longer need to keep track of business mileage, business meals and entertaining, and other employee business expenses.  And there is no longer the need to keep track of job-seeking expenses, including travel to interviews, or educational expenses to maintain or improve skills required in your current trade or business.  Investment and tax preparation costs are no longer deductible, so no longer a need to keep track of these expenses.  Of course, this simplification comes at a cost – the loss of a potentially large tax deduction.

The Act changes tax planning considerations, and makes year-end planning simpler.

To begin, with the increased Standard Deduction, unfortunately made much less attractive for taxpayers without dependents due to the loss of the personal exemption deduction, there will be less taxpayers who will benefit from itemizing.

For those who could be able to benefit from itemizing –

* It will still be possible to “bunch” medical expenses and charitable contributions – that is claim additional deductions in a year when you may be able to itemize, so that you itemize every other year.  The use of a charitable donor-advised fund account and contributions of appreciated stock at year-end will still apply.  And during the year, the Qualified Charitable Distribution (click here) is an even more attractive strategy for those age 70½ and over.

* With the limitation of the itemized deduction for combined property and state and local income or sales taxes to $10,000, there is little that can be done here, other than to attempt to maximize the deduction.  If the $10,000 maximum will not be already met, it is still a good idea to make any 4^th quarter state estimated tax payment in December instead of January of the next year.  And pre-payment, if possible, of property taxes can be used to bunch deductions. 

* One can still make a 13^th mortgage payment to bunch the interest deduction.

* The total elimination of job related, investment, and tax preparation expenses, and other miscellaneous deductions subject to the 2% of AGI exclusion, makes these deductions no longer an issue, so there is nothing more than can be done.

* And the changes to the dreaded Alternative Minimum Tax (AMT) will create less victims, so AMT considerations will no longer apply for most.

While the new limitations on the mortgage interest deduction simplifies the Tax Code, it greatly complicates recordkeeping for taxpayers and potentially for tax professionals.  Under the GOP Tax Act interest on home equity debt, regardless of the amount of the debt principal, is no longer deductible.  Period.  There is grandfathering of existing acquisition debt interest rules – but there is NO grandfathering of existing home equity debt.  Taxpayers will need to separately track acquisition and home equity debt going forward, and going back to day one on all current mortgage debt! 

I do believe in the original House version of the bill all existing mortgage debt was “grandfathered” – including home equity debt.  While I can understand, and agree with, the philosophy of limiting deductible mortgage interest to acquisition debt, for practicality sake I wish that existing home equity debt had been included in the grandfathering.

Taxpayers have always been required to keep separate track of acquisition and home equity debt, but few actually did due to the allowance of a deduction for interest on up to $100,000 of home equity debt.  This is now something that MUST be done, especially for taxpayers with existing mortgages.

Even if a homeowner never incurred any separate home equity debt – never took out a separate home equity loan or opened a home equity line of credit – if an original acquisition mortgage was ever refinanced they may have home equity debt.  The additional closing costs of each refinance that were added to the principal of the refinanced mortgage loan is home equity debt.  The only way you would avoid home equity debt in such a situation is if you literally refinanced only the principal from each old mortgage and paid all closing costs in cash.

For example - you purchased a home in 2011.  You have had only one mortgage, from the original purchase, and no home equity debt.  You refinanced the original mortgage in 2015 to get a better rate.  The principal balance on the original mortgage was $197,374.  The principal balance of the refinanced mortgage was $200,000.  You did not take any money “out”, and paid a little over $1,000 at the closing.  The difference is the closing costs for title insurance, inspections, fees, etc. etc.  You have have acquisition debt of $197,374 and home equity debt of $2,626.   

I will be rewriting my Mortgage Interest Guide, which includes worksheets for keeping track of mortgage debt and a detailed example of how to use them, to reflect the new rules for 2018 and beyond.  It is only $2.00, delivered as a pdf email attachment.  I will let you know here when it is available.

So, as you can see, not only has the Tax Code been drastically changed by the new GOP Tax Act, but also the year-round recordkeeping requirements of taxpayers.

TTFN

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