In a Notice, IRS has amended the safe harbor that homeowners participating in the Treasury Department’s HFA Hardest Hit Fund may use for computing the amount of mortgage interest deductible under Code Sec. 163 and real property taxes deductible under Code Sec. 164(a)(1) relating to the homeowner’s principal residence. The amendment reflects recent legislation that limits the itemized deduction for state and local taxes (SALT).
Background. Notice 2017-40, 2017-32 IRB, provides a safe harbor method for computing the deductions under Code Sec. 163 and Code Sec. 164 on a principal residence for homeowners participating in a program designated by a state housing finance agency (State HFA) using funds allocated from the HFA Hardest Hit Fund (State Program).
Under Notice 2017-40, the safe harbor is available for the tax year if the homeowner (1) meets the requirements to deduct all of the mortgage interest and real property taxes relating to the principal residence under Code Sec. 163 and Code Sec. 164, respectively; and (2) participates in a State Program in which the program payments can be used to pay interest on the home mortgage.
Notice 2017-40 provides that the safe harbor method is available for tax years 2010 through 2021. Under the safe harbor, a homeowner may deduct on his or her federal income tax return the lesser of:
- The sum of all payments on the home mortgage that the homeowner actually makes during a tax year to the mortgage servicer or the State HFA; and
- The sum of amounts shown on Form 1098, Mortgage Interest Statement, for mortgage interest received, real property taxes, and mortgage insurance premiums (if deductible for the tax year under Code Sec. 163(h)(3)(E)).
Observation: The deduction for mortgage insurance premiums as qualified residence interest under Code Sec. 163(h)(3)(E) expired at the end of 2017, and it is presently uncertain as to whether and when this provision will be further extended, made permanent, or left expired.
Code Sec. 164(b)(6)(B) provides that, in the case of an individual, for tax years beginning after Dec. 31, 2017, and before Jan. 1, 2026, the aggregate amount of taxes taken into account under Code Sec. 164(a)(1), Code Sec. 164(a)(2), and Code Sec. 164(a)(3) and Code Sec. 164(b)(5) (i.e., SALT) for any tax year may not exceed $10,000 ($5,000 in the case of an individual filing a separate return).
New modifications to safe harbor.Notice 2018-63 amplifies Notice 2017-40 to provide that the safe harbor, as modified, is available even if the limitation in Code Sec. 164(b)(6)(B) precludes a homeowner from deducting all of the real property taxes imposed on the principal residence. The amplification thus preserves the availability of the safe harbor computation for most homeowners who participate in a State Program in which program payments can be used to pay interest on a home mortgage.
If the homeowner’s deduction, as provided by the safe harbor, is the sum of all payments made by the homeowner during a tax year, then the homeowner may first allocate amounts paid to mortgage interest up to the amount shown on Form 1098. The homeowner may then use any reasonable method to allocate the remaining balance of the payments to real property taxes, mortgage insurance premiums, home insurance premiums, and principal.
Regardless of how a homeowner determines the deductible amount under this safe harbor, any part of such amount that is allocated to state or local property taxes is subject to the limitation in Code Sec. 164(b)(6)(B).
References: For the safe harbor for taxpayers receiving government assistance, see FTC 2d/FIN ¶ K-4504.1.