Negative Amoritization

[Zee]

Last year, there was several posts on the deductibility of deferred interest (negative amortization) added back to the principal on client's mortgage loans.

One poster (Koss) seemed to believe the deferred interest was currently deductible because "the unpaid interest is actually paid because it's capitalized as a new loan".

With the current Arm loan situation, it's possible many of us may be confronted with client's in this situation, so I'm hoping to "refresh" the discussion.

First, I'm wondering how the banks handle this. I read banks are allowed to report the deferred interest as earnings. How do they report the addition to principle on the 1098? Is it shown as interest?

Unless the bank reports the amount as interest, it doesn't seem that it's deductible for a cash-basis taxpayer (maybe for an accrual-basis taxpayer).

Any input?

[New York Enrolled Agent]

Suggest you read PLR 8438072 and Rev Ruling 77-135. I do not believe they agree with the notion of a current deduction with respect to cash basis taxpayers.

[les grans]

Deduct it when you pay it...

Interest isn't deductible until it's been paid. "Adding" it to "principal" is *not* paying it, and does not make it deductible. How the bank reports it is 1.) probably not a *tax* treatment and 2.) irrelevant.

And, to head off at least one responder, when you borrow from the same institution [seller or lender] to pay something, it's not considered paid.

[Zee]

I agree, with the exception of an accrual-basis tax client. IMHO, an accrual-basis client would also deduct the total amount of interest accrued at year end (including any amount attributable to the negative amortization). I was surprised that others thought it was deductible by a cash-basis taxpayer, and thought a revisit might help.

Of course, in most cases, how a bank reports the transaction may not matter to the recipient taxpayer.

I was shocked, however, to learn how banks report this type of interest. It overstates income, and understates potential write-offs. Other readers might find this article interesting.

http://calculatedrisk.blogspot.com/2007/10/accounting-for-negative-amortization.html

It's just another contributing factor to the current mortgage and housing crisis we're experiencing. Banks can/do distort their financial results using negative amortization as a tool. I didn't know this, and thought others might be interested.

[Snaggletooth]

Not Interest

I believe deductions can be "paid" by borrowing money to pay them. This would include items "paid" in the process of loan recapitalization. Similar to "paying" a medical bill with a credit card. Such a medical bill is deductible. Property taxes, for example, are often paid via refinancing.

However, I believe there are statutory restrictions in the tax code for interest. Interest must be directly paid. All I have seen or read confirms this.