Homeowners that itemize “qualified residence” interest should be aware of the IRS rules and new Form 1098 reporting requirements. The allowed deduction may not match what the bank reports on Form 1098 and the IRS can target this deduction in tax return audits.
If you own a home with a mortgage, you should receive an IRS form from your lender each year with information that is used to claim an itemized deduction for qualified residence interest. For 2016, that form should include additional information that could trigger IRS attention.
IRS Rules for Deducting Home Mortgage Interest
Unlike most other types of personal interest, home mortgage interest that meets the definition of “qualified residence interest” can be claimed as an itemized deduction on federal income tax returns.
Deduction Terminology
A qualified residence includes your principal residence and up to one additional personal residence. If you own two or more additional residences, you can specify which one is treated as the second residence for each tax year for the purpose of applying the qualified residence interest rules.
Qualified residence interest is defined as interest on up to $1 million of “acquisition debt” plus interest on up to $100,000 of “home equity debt.”
Acquisition debt is:
+ Incurred to acquire, construct, or substantially improve a qualified residence, and
+ Secured by a qualified residence.
Home equity debt is debt (other than acquisition debt) that is secured by a qualified residence. Unlike acquisition debt, the proceeds from home equity debt can be used for any purpose without affecting deductibility of interest under regular tax rules. However, interest on home equity debt is deductible under the alternative minimum tax (AMT) rules only to the extent debt proceeds are used to acquire, construct, or substantially improve a qualified residence.
Important note: If married and filing separately from your spouse, you can deduct half of the eligible mortgage interest paid on your separate returns.
Basic Reporting Requirements
By law, home mortgage lenders must provide certain information each year to borrowers on Form 1098, Mortgage Interest Statement.The IRS also receives a copy of this form, which includes the following information:
+ The name and address of the borrower,
+ The amount of interest received by the lender from the borrower during the previous calendar year, and
+ The amount of mortgage points received by the lender from the borrower during the previous calendar year and whether such points were paid directly by the borrower.
The IRS also may require additional information to be reported on Form 1098. For instance, IRS regulations require Form 1098 to include the borrower’s taxpayer identification number (TIN), which is the borrower’s Social Security Number if he or she is a citizen.
Recent Legislation | New Requirements
For Forms 1098 issued to payers after December 31, 2016, the Surface Transportation and Veterans Health Care Choice Improvement Act of 2015 added the following new information reporting requirements:
+ The mortgage origination date,
+ The outstanding principal balance, and
+ The address of the property that secures the mortgage (or a description if the property doesn’t have an address).
Home mortgage lenders must report the amount of the outstanding mortgage principal as of the beginning of the calendar year for which the Form 1098 is provided. Knowing the outstanding mortgage principal balance allows the IRS to more easily identify taxpayers who attempt to deduct interest on loan balances above the combined $1.1 million limit for acquisition debt and home equity debt.
Knowing the address of the property securing the mortgage allows the IRS to more easily identify taxpayers who attempt to claim mortgage interest deductions for more than two residences.
Effect on 2016 Tax Returns
Your mortgage lender should have included this additional information on the 1098 forms that were issued earlier this year. Those forms report information for calendar year 2016, and the IRS can use the additional information to check home mortgage interest deductions claimed on 2016 federal income tax returns. Those deductions present an enticing audit target, because they cost the federal government over $300 billion of tax revenue each year.
Based on the additional information reported on your Form 1098 for 2016, the IRS will know if you claim mortgage interest deductions for more than two residences or interest deductions for more than $1.1 million of combined acquisition debt and home equity debt. These issues could trigger an audit and result in an unfavorable outcome.
A red flag may be raised if the amount of your qualified residence interest deduction differs from the combined mortgage interest reported on your Form(s) 1098. Sometimes, this may happen if you have more than $1.1 million of combined acquisition debt or own more than two homes.
Get It Right
The bottom line is the IRS has more information to monitor qualified residence interest deductions than in previous years. It is important to understand the rules and calculate deductions carefully.
Our tax advisors can help you comply with the IRS rules, including amending previous returns that may have been filed with incorrect information. Although the rules on qualified residence interest may seem straightforward, there are some lesser-known nuances that could affect the amount you can write off.