Are Mortgage Insurance Premiums Deductible?
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.
"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 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.
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.
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.