IRS Letter Examination on Qualified Mort Interest

[S T]

I knew at some point, the day would arrive,

Sure enough a 2011 Letter examination on the Schedule A Qualified Mortgage Interest Deduction. Okay forget that I did attach schedules and did all I could and limited, now I have to go through an abundance of paperwork.

Unique situation in this taxpayer case, Personal Residence #1 til June 30, purchased new Personal Residence and Personal Residence # 1 turned into a Rental. That is all good, except the new home purchased and new loan are over the $ 1mil - noted on the Return,

then to complicate matters, to obtain lower interest rates ONLY, the refinanced the old Personal Residence # 1 now a Rental for the last 6 months of 2011, and refinanced the New Personal Residence. No additional $$ - just interest rates and some closing costs.

Anyone had the privilege of addressing one of these Qualified Interest Examinations, they want me to complete an 886A Worksheet, and not quite sure how to address that with all of the converted to Sched E, new loans on Personal and refinances.

I did the best I could on my original calculations using CFS Tax Tools - probably not perfect, but better than not addressing at all.

Any words of wisdom or an outline of how to approach - I have to have t/p pull some loan docs on all of this as well

Guess I am lucky it is a Tax Examination by fax or mail

Sandy

[TXEA]

This is simply a DIF score Audit

As you know the amount of interest expense triggered the audit. It sounds like you addressed the information the IRS is looking for by allocating the interest as appropriate to Sch A and Sch E during the year, and limiting the deduction based on the threshold of qualified mortgage indebtedness.

Just review your calculations and the rules for the calculations and send them to the IRS. There can't be too much of an adjustment if you made an effort to allocate based on the rules.

[taxea]

as TXEA says, send a detailed statement that includes explanation and calculations. When you submit an original return nobody pays attention to anything you include. If all this info was included then send a copy of the details in the original return.

[S T]

Thanks for the "kudos" I tried on the original filed return to report correctly - we will see on how that plays out now submitting the very "large" document list that the IRS wants..

I so hope my CFS Tax Tools calculations are close in the range of the allowed calculations. Now I have to prepare them manually on the IRS form, so not sure what result I will obtain.

Keep smiling, right!

Sandy

[Golden Rocket]

Manual Calculations

I'll probably get disagreement from some of the "whiz kid software" crowd, but have you considered doing a manual allocation
of this interest mess? The deductible interest should be Mortgage #1 up to 6 months, plus Mortgage #2 minus the interest
attributable to whatever principle is over $1MM. You should be able to do this without having to rely on some whiz-bang tool.

The tools are OK, but often the time spent getting them registered, set-up, and operable exceed the old-fashioned pencil-and-
eraser methods.

[S T]

Thanks Snags,

I use manual calculations when I am trying to understand a form, my CFS Tax Tools program does a good job and it is quick-

So now back to rechecking what I did 2 years ago and the why I did and wherefore's even with all of the documents, etc I keep in file. Could always be the user error - I just hope not!

This is a PITA, but I guess necessary since we received the request.

Sandy

[S T]

New question as I am preparing the paperwork and outline for this Examination Correspondence request for the Qualified Mortgage Interest -

As stated above, t/p purchased a new personal residence and the new loan was $ 1.5 million. I also deducted points for this loan of $ 15,000 as listed on the HUD-1 stmt -

My question now is - would the be points subject to the Qualified Mortgage Interest limitation? They were stated separately from the mortgage interest paid on the $ 1.5 mil loan which was limited on the return.

Thanks

Sandy

[TaxGuyBill]

I would GUESS that the points would be limited as well. Points are considered prepaid interest, and are usually based on a percentage of the total loan, so it would seem 'logical' (not that taxes are logical) that points would be limited in the same way as mortgage interest. Make sure that they are otherwise deductible.

http://www.irs.gov/publications/p936/ar02.html#en_US_2013_publink1000229936

Also, I want to make sure that you know that you can use the $100,000 home equity debt limit and add it to the $1,000,000 limit to get a total limit of $1,100,000.

http://www.irs.gov/pub/irs-drop/rr-2010-25.pdf

[Burke]

My question now is - would the be points subject to the Qualified Mortgage Interest limitation? They were stated separately from the mortgage interest paid on the $ 1.5 mil loan which was limited on the return. Thanks Sandy

Yes, see Pub 936 for the table on page 12, and the instructions for Line 10 on Page 13 regarding deductible points. You use the same percentage for points that appears on Line 11 of the table. If you took the full amount, maybe that is why the audit came up.

[S T]

Yep! I might have not reported correctly. This return was so confusing on mortgage interest deductions for the year in question 2011, with primary residence to conversion to rental, and a 2nd home in place, add in purchasing a new home mid- year well over the $ 1.1 Loan limit....., . I am sure there are some errors in my calculations, however, I did make "some calculations for limitation". An attempt (while maybe not correct) was made.

Thanks for the info on the points and qualified interest limitation,

Okay off to mitigate some damage control, and gather more info from the client to submit.



I am so glad this board and posters are here, and the assistance and honest answers I receive.

Thanks

Sandy

[New York Enrolled Agent]

Reg §1.163-10T(j) would appear to confirm that the points are included in the calculation for qualified residence interest. It is always best to read in its entirety but a snip follows.

(2) Special rules for cash-basis taxpayers.


(i) Points deductible in year paid under section 461(g)(2).
If points described in section 461(g)(2) (certain points paid in respect of debt incurred in connection with the purchase or improvement of a principal residence) are paid with respect to a debt, the amount of such points is qualified residence interest.

(ii) Points and other prepaid interest described in section 461(g)(1).

The amount of points ... that is qualified residence interest shall be determined under the rules of paragraphs (c) through (e) of this section in the same manner as any other interest paid with respect to the debt in the taxable year to which such payments are allocable under section 461(g)(1).


(3) Examples.
...
Example (2). R purchases a principal residence on June 17, 1987. As part of the purchase price, R obtains a conventional 30-year mortgage, secured by the residence. At closing, R pays 2 1/2 points on the mortgage and interest on the mortgage for the period June 17, 1987 through June 30, 1987. The points are actually paid by R and are not merely withheld from the loan proceeds. R incurs no additional secured debt during 1987. Assuming that the points satisfy the requirements of section 461(g)(2), the entire amount of points and the interest paid at closing are qualified residence interest.

[S T]

First of all thanks to all that responded to my posts on this.

A question, as I work through the paperwork IRS wants, is there someone on the board via PM that would be willing to communicate with me and check my numbers - This calculation has always been a challenge for me, however, I always try to take note and address for limitations on client situations.

I could certainly use some support and wisdom , before I submit to IRS. This particular client just has too much going on in one year with Mortgage Interest and want to make sure that I am submitting the right amounts on the calculations and presenting correctly -- based on what IRS is requesting for their Letter Correspondence.

Thanks

Sandy

[Roland Slugg]

Hello Sandy

I have read all the messages in this thread, and I have formed the opinion that you're more worried about this than you should be. Based on the facts you've given, I don't believe it's all that complicated. So relax. Let me offer a bit of help, if I can, some of which repeats what others have said above.

You didn't say how much the loan was on the first residence, so I'm assuming it was less than $1M. If so, all the interest paid in 2011 to the date converted to rental is deductible. The rest should have been reported on Schedule E, page 1, rental property.

As for the new house and related loan: I understand the loan was $1.5M, and it was refinanced later in the same year to get a lower interest rate. To figure the deductible portion of the interest paid on those two loans, do this for each one: Multiply the interest paid by a fraction, the numerator of which is $1M and the denominator of which is the average outstanding principal balance of that loan for the time it was open during the year. For both of those loans that denominator will probably be very close to $1.5M, as the principal was probably not paid down very much, if at all, during 2011.

Add the result of the old loan's interest allocation to the total of the calculations for the new and refinanced loans for the new house, and that is your total deduction.

For points the deduction should have been $10,000, not the full $15,000. The calculation is the same ... $15k x $1M/$1.5M = $10k.

If the loan on the old house was more than $1M, instead of less as I have assumed, then figure the deductible interest on that loan using the same formula described above for the new loan. Finally, if there was a period of overlap when both loans were outstanding ... i.e. the new home's loan was funded, but the old home was still occupied by the T/Ps, the $1M limitation will apply, but you can pick which loan's interest to include in the deductible total. Obviously, you would want to deduct the interest on the loan with the higher interest rate. This might include deducting all the interest on the old home's loan, if that loan's balance was under $1M, and a portion of the interest on the new home's $1.5M loan ... for the period of the overlap.

Finally, I noted that in one of your posts you referred to deducting interest on $1.1M of loan principal, and you are correct about that. Even though there is a single loan for $1.5M, $100k of that amount may be treated as "home equity debt." This was pointed out by TaxGuyBill in his post above and his very helpful link to RevRule 2010-25. (In my initial post I had incorrectly indicated that the additional $100k could not be counted because there was not a second loan. Thanks to TaxGuyBill.)

One more thing: If I were in your shoes, I would probably NOT complete and submit to the IRS that 886A worksheet you referred to, but that would depend on how long and complicated it is. Instead I would prepare a nicely laid-out schedule of my own design and submit that. Of course, if the IRS is also requesting other documentation, to prove the existence of the loans, say, than that will need to be furnished as well.

Good luck with this!