IRS Revises Form 1098, Tightening Scrutiny on Mortgage Interest Deduction

Form 1098, received by millions of homeowners across the nation from their lenders, totals up the interest those homeowners paid on their mortgage throughout the year. Lenders are required by law to send it to the IRS.

This year’s form, however, contains some important differences, and it’s critical to be aware of them to avoid an audit. Your lender is now required to disclose additional information, including your loan’s outstanding principal at the start of the year, the origination date of your mortgage, and the address of the home in question.

Why the changes? The IRS has not officially commented, but increased scrutiny of home mortgage interest deductions appears to be the culprit. All told, the deduction is a massive write-off, costing the government a projected $357 billion in revenue from 2016 to 2020.

Without enough data points, the IRS has had trouble verifying which properties qualify for interest deductions, or whether the amounts claimed indeed match up with either reported incomes or mortgage amounts exceeding tax code limits of $1 million for home acquisition debt and $100,000 for home equity debt.

According to IRS Publication 936, acquisition debt is the mortgage amount used to “buy, build, or substantially improve” a principal residence or secondary home. Home equity debt is money secured by your mortgage used for reasons other than buying, building, or improving that home.

If you exceed the acquisition debt limit, you can use up to $100,000 of the home equity debt, resulting in a total deductible of $1.1 million.

Homeowners should be aware of certain refinancings, according to tax professionals. Charles Benway of Main Street Financial, a CPA and certified financial planner, says many homeowners aren’t cognizant that their acquisition debt for federal tax purposes declines as they pay down their mortgage.

He uses a hypothetical example to illustrate his point. Imagine you buy a house with a $500,000 mortgage, and over time pay it down to $300,000. During this period, your home appreciates in value to $700,000, and you refinance to a new loan of $500,000, paying off the $300,000 balance you still owed. You spend the $200,000 on other expenses, including student loan debt, a new car, and credit card bills.

In such a scenario, your acquisition debt remains at $300,000. Your home equity debt limit is $100,000, totaling $400,000 in mortgage debt that qualifies for deduction. Since that amount is less than the $500,000 value of your refinanced loan, only 80% of the interest is deductible on your tax return.

While somewhat complicated, the IRS will be better equipped to locate discrepancies with the new data it is requiring. Be mindful of the new changes to Form 1098. Do not assume that the amount of mortgage interest you paid automatically corresponds to the amount you can deduct. For more information, visit the IRS website to review mortgage deduction rules, and consult a tax professional.

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