THE MORTGAGE INTEREST DILEMMA
In my opinion the area of the Tax Code where proper documentation and strict adherence to the law is perhaps the most overlooked (or actually ignored) is the deduction for mortgage interest – both on Schedule A and Form 6251.
Taxpayers are required to keep separate track of acquisition debt and home equity debt, to make sure that the deduction on Schedule A does not include interest on debt principal that exceed the statutory maximums, and to determine what interest deduction to add back on Form 6251 when calculating Alternative Minimum Taxable Income.
I firmly believe that 99.5% of taxpayers do not do this. I do not know of any taxpayer who does.
And I expect that the majority of tax preparers do not do this for their taxpayer clients.
Most taxpayers, and a large percentage of tax preparers, merely take the amount of “Mortgage interest received from payer(s)/borrower(s)” reported in Box 1 of the Form 1098 Mortgage Interest Statements and enter it on Line 10 of Schedule A.
And similarly, most taxpayers, and a large percentage of tax preparers, do not include any adjustment to the Schedule A mortgage interest deduction on Line 4 of Form 6251.
It is sometimes easy to identify the difference between acquisition debt and home-equity debt if the taxpayer has one acquisition mortgage and a separate home equity loan and/or line of credit. But home equity debt often arises from multiple refinancings and consolidations over an extended period of years.
I have one client who had paid off his acquisition mortgage early, but was advised by a college financial aid consultant to take out a new $400,000 mortgage on his home and use the proceeds to purchase an annuity investment as a way to increase possible college financial aid for his children. I have absolutely no idea whether this “scheme” works, and at this point will not make any comment on whether or not it is appropriate or ethical (does anyone wish to comment?). Since the $400,000 in mortgage debt principal was not used to “buy, build, or substantially improve” my client’s home it is all home equity debt. So only the interest on the first $100,000 is deductible on Schedule A and none of it is deductible in calculating the dreaded Alternative Minimum Tax.
If the interest rate on this mortgage is 3.45% I claim only $3,450 as a mortgage interest deduction on the client’s Schedule A, regardless of what is reported on the Form 1098, and add back the $3,450 on Line 4 of Form 6251. Unfortunately, because of the client’s level or income and amount of taxes deducted on Schedule A, he is always a victim of the dreaded AMT.
To be fair to my fellow tax preparers, many do not adjust the Schedule A or Form 6251 deduction for home equity interest because their clients have not kept track of the separate types of debt and therefore do not provide separate principal or interest numbers.
And to continue to be fair to my colleagues, the responsibility for keeping separate track of the two types of mortgage debt (actually three if you consider “grandfathered” mortgage debt) truly lies with the taxpayer client and not the tax preparer.
Obviously the best solution to this issue is to have boxes on the Form 1098 for “acquisition debt” principal and interest and “home equity debt” principal and interest, and require banks and other mortgage providers to properly report these amounts thereon. But this would require a lot more information gathering and paperwork on the part of mortgage providers, and I doubt if the banking lobby would allow a law requiring this additional reporting to pass.
Getting our clients to provide us with all the information necessary to correctly and completely prepare their tax returns is perhaps the hardest task we face as tax professionals. It is truly often like “pulling teeth”.
Since most taxpayers have not kept proper documentation of their mortgage borrowings over the years, often because they do not know they need to, getting the needed information is sometimes almost impossible. The client is not willing to go back over all of his/her refinancings and consolidations over the years, and they certainly do not want to pay us at our normal hourly rate to do this. Nor, to be perfectly honest (at least for me), do we have a desire to waste valuable time during the tax filing season to undertake this sometimes daunting task.
I have created a “Mortgage Interest Guide” as part of my Dollar Store of tax guides. In this guide I explain the various types of mortgage debt and the deduction limitations, and go into detail on how refinancing an acquisition debt mortgage can result in home equity debt.
I also include in this guide two worksheets – one for Acquisition Debt Activity and one for Home Equity Debt activity – and provide a detailed example of how to use the debt activity worksheets.
In this guide I remind the reader that –
“It is the responsibility of the taxpayer to keep track of the separate acquisition and home equity debt balances, The bank or mortgage company will not do it.”
And advise readers that –
“It is very important that homeowners keep good records of their separate acquisition debt and home equity debt so that the correct amount of mortgage interest is claimed on Schedule A and Form 6251.”
This guide is a great way for tax preparers to introduce new homeowners to the rules and responsibilities for deducting mortgage interest. You can give this guide to clients who have just purchased a new home, or offer it as a free “gift” to new homeowners in your town as a part of a marketing and promotion program to get new clients.
And the debt activity worksheets in the guide are excellent tools for use in your practice if you choose to maintain the documentation for your clients.
I am offering limited “reprint rights” for my Mortgage Interest Guide to my fellow tax professionals to purchase and use for just such purposes. The cost of the limited license and right to reprint the Mortgage Interest Guide is only $14.95.
You can purchase a copy of this guide for $1.00 from my Dollar Store to review before deciding if you want the reprint rights. I will deduct the $1.00 from the cost of the reprint license if you do decide to purchase it.
Send your check or money order for $1.00 or $14.95, payable to TAXES AND ACCOUNTING, INC, to –
AND ACCOUNTING INC
OFFICE BOX A
HAWLEY PA 18428
Your comments and suggestions on my Mortgage Interest Guide are welcomed and encouraged.