15.6 Mortgage Insurance Premiums and Other Payment Rules

Payments to the bank or lending institution holding your mortgage may include interest, principal payments, taxes, and insurance premiums. You may deduct eligible home mortgage interest (15.2, 15.3), taxes (16.4), and mortgage insurance premiums.

In the year you sell your home, check your settlement papers for interest charged up to the date of sale; this amount is deductible.

Law Alert

No Deduction for Mortgage Insurance Premiums Without Law Change

The deduction for mortgage insurance premiums expired at the end of 2011. See the e-Supplement at jklasser.com for an update, if any, on a possible extension to 2012.

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Mortgage insurance premiums.

The law that allowed a deduction for mortgage insurance premiums expired at the end of 2011. Unless Congress extends the law, any insurance premiums paid in 2012 are not deductible. Prepayments of premiums allocable to 2012 are also not deductible, so if you prepaid premiums before 2012 that were deductible under IRS rules over the shorter of the mortgage term or 84 months, any prepaid amount allocable to 2012 will not be deductible unless Congress extends the prior law. See the e-Supplement at jklasser.com for an update, if any, on a possible extension to 2012.

Mortgage credit.

If you qualify for the special tax credit for interest on qualified home mortgage certificates, you only deduct interest in excess of the allowable credit (15.1).

Filing Tip

Joint Liability on Mortgage

If you do not personally receive a Form 1098 but a person (other than your spouse with whom you file a joint return) who is also liable for and paid interest on the mortgage received a Form 1098, you deduct your share of the interest and attach a statement to your Schedule A showing the name and address of the person who received the form. If you are the payer of record on a mortgage on which there are other borrowers entitled to a deduction for the interest shown on the Form 1098 you received, provide them with information on their share of the deductible amount.

The Tax Court has allowed a joint obligor to deduct his or her payment of another obligor’s share of the mortgage interest if the payment is made to avoid the loss of the property, and payment is made with his or her separate funds.

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Prepayment penalty.

A penalty for prepayment of a home mortgage is deductible as home mortgage interest provided the penalty is not for specific services provided by the mortgage holder.

Mortgage assistance payments.

You may not deduct interest paid on your behalf under Section 235 of the National Housing Act.

Delinquency charges for late payment.

According to the IRS, a late payment charge is deductible as mortgage interest if it was not for a specific service provided by the mortgage holder. In one case, the Tax Court agreed with the IRS that delinquency charges imposed by a bank were not interest where they were a flat percentage of the installment due, regardless of how late payment was. The late charges were primarily imposed by the bank to recoup costs related to collection efforts, such as telephone calls, letters, and supervisory reviews. They were also intended to discourage untimely payments by imposing a penalty.

Graduated payment mortgages.

Monthly payments are initially smaller than under the standard mortgage on the same amount of principal, but payments increase each year over the first five- or 10-year period and continue at the increased monthly amount for the balance of the mortgage term. As a cash-basis taxpayer, you deduct the amount of interest actually paid even though, during the early years of the mortgage, payments are less than the interest owed on the loan. The unpaid interest is added to the loan principal, and future interest is figured on the increased unpaid mortgage loan balance. The bank, in a year-end statement, will identify the amount of interest actually paid. (An accrual-basis taxpayer may deduct the accrued interest each year.)

Reverse mortgage loan.

Homeowners who own their homes outright may in certain states cash in on their equity by taking a “reverse mortgage loan.” Typically, 80% of the value of the home is paid by a bank to a homeowner in a lump sum or in installments. Principal is due when the home is sold or when the homeowner dies; interest is added to the loan and is payable when the principal is paid. The IRS has ruled that an interest deduction may be claimed by a cash-basis home-owner only when the interest is paid, not when the interest is added to the outstanding loan balance. A deduction is subject to the limits for interest on home equity loans (15.3).

Shared appreciation mortgage.

Under a shared appreciation mortgage (SAM) for a personal residence, the lender agrees to charge a fixed rate of interest that is lower than the prevailing market rate. In return, the homeowner promises to pay a percentage of the appreciation on the property at a later date to make up the difference. The fixed-rate interest is deductible when paid and the percentage of appreciation is also treated as interest that you can deduct in the year of payment, subject to the limits discussed in 15.2. For example, you agree to pay interest of 5% plus 40% of the appreciation in the value of the property within 10 years or earlier if you sell the home or pay off the mortgage. If, at the end of 10 years, the residence is not sold or the loan repaid, you may refinance at the prevailing rate the outstanding balance plus the interest based on the appreciation. If you refinance with the same lender, you may not claim an immediate deduction for the extra interest. The execution of a note is not considered payment. The amount covering the extra interest is deducted ratably over the period of the new loan. If you refinance with another lender and use the funds to pay off the old loan plus the extra interest, the extra interest is deductible in the year of payment, subject to the deduction limits (15.2).

Redeemable ground rents.

In a ground rent arrangement, you lease rather than buy the land on which your home is located. Ground rent is deductible as mortgage interest if: (1) the land you lease is for a term exceeding 15 years (including renewal periods) and is freely assignable; (2) you have a present or future right to end the lease and buy the entire interest; and (3) the lessor’s interest in the land is primarily a security interest. Payments to end the lease and buy the lessor’s interest are not deductible ground rents.

Court Decision

Current Deduction for Points on Refinancing

Huntsman replaced a three-year loan used to purchase his principal residence with a 30-year mortgage. He deducted $4,400 of points paid on the new mortgage. The IRS and the Tax Court held that the points had to be deducted over the 30-year loan term.

The Federal Appeals Court for the Eighth Circuit disagreed and allowed a full deduction in the year the points were paid. The first loan was temporary and merely a step in obtaining permanent financing for the purchase of the principal residence.

The IRS has announced that in areas outside of the Eighth Circuit, it will continue to disallow full deductions in the year of payment for points paid on refinancings. The Eighth Circuit includes only these states: Minnesota, Iowa, North and South Dakota, Nebraska, Missouri, and Arkansas. In these states, the IRS will not challenge deductions for points on refinancing agreements similar to Huntsman’s that replace short-term financing with long-term permanent financing.

In a later case, the Tax Court held that the Huntsman exception does not apply where a borrower refinances a long-term mortgage to take advantage of lower interest rates; the points must be deducted over the term of the new mortgage.

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