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April 19, 1999, Revised December
6, 2007
So long as mortgage interest is deductible, borrower payments for
services required by lenders to reduce their risk, including mortgage
insurance and title insurance, should also be deductible. Under IRS rules,
however, they are not. Congress made a temporary exception for mortgage
insurance premiums paid in 2007 on loans originated in 2007, but whether
this will be made permanent is not clear.
Why
Mortgage Insurance Premiums Should Be Deductible
"My tax advisor said
that I should deduct my mortgage insurance premiums from my taxable
income, but others have warned me that the premiums are not deductible.
Who is right?"
In some
sense, they are both right. If one assumes that IRS must be consistent in
establishing deductibility, then mortgage insurance premiums are
deductible. The IRS, however, says that consistency be damned, they are
not deductible. Hence, if you deduct them and are audited, IRS is sure to
challenge you.
Consistency in the rules regarding
deductibility means that if an expense X is deductible, and if expense Y
is functionally identical to X, then Y should also be deductible.
Interest payments on home
mortgages are deductible, and no distinction is made by IRS between the
portion of the interest payment that represents compensation for the time
value of money, and the portion that represents compensation for risk. If
a low-risk borrower pays 7%, for example, while a high-risk borrower- pays
9%, the entire interest payment of the high-risk borrower is deductible.
However, if the lender charges both borrowers 7% but requires that the
high-risk borrower purchase mortgage insurance, with the mortgage insurer
now collecting the 2% or its equivalent, IRS will not allow the 2% to be
deducted. That is inconsistent.
The IRS classifies mortgage
insurance premiums as payments by borrowers for services provided by the
lender, similar to an appraisal fee, and as a general matter such payments
are not deductible. The problem with this position is that the lender is
not in fact providing any service in connection with mortgage insurance.
The mortgage insurance premium is a payment for risk, in exactly the same
way that the 2% rate increment charged the high-risk borrower is a payment
for risk. Apart from possible differences in price, the borrower doesn't
care whether the lender receives the payment and takes the risk, or the
mortgage insurance company receives the payment and takes the risk.
Title
Insurance Should Also Be Deductible
Title insurance
premiums on a policy that protects the lender only also
should be deductible, but aren't. The same is true of expenses billed to
the borrower that are incurred by a lender in connection with a loan, such
as a credit check or appraisal. IRS says they are not deductible because
the borrower receives a service for them, but this is a fiction. The
lender requires these services as condition for granting the loan, and
they provide little or nothing of value to the borrower beyond the loan
itself. Furthermore, if the lender elects to cover these expenses in the
interest rate or points, they are fully deductible.
Congress
to the Rescue -- Sort Of
The 109th Congress
in its final hours passed a law that made
mortgage insurance premiums deductible. The law and its
interpretation by IRS is hard to fathom. Holden Lewis who writes for
BankRate and I worked together on trying to decipher it. Our best guess is
that it restricts deductibility to premiums paid in 2007 on loans originated
in 2007.
See Holden Lewis,
What Does the IRS Mean?
Whether anything will be done to extend it is anybody's guess.
Copyright Jack Guttentag
2007 |