Mortgage Interest Audit

[lefty]

My client got the mortgage interest audit.  Turns out they over-reported their interest since the loan is more than $750,000.  We expected them to adjust the taxes and send a bill.

Instead they sent a response saying they are not allowed to deduct any interest at all for 2021 because "they did not establish the amount shown was interest expense and was actually paid".

What documents can we provide to prove mortgage interest was legit and it was paid (besides the 1098 form and maybe the closing statement from the purchase)?

[sjrcpa]

Copies of cancelled checks or autopay receipts for the monthly payments.

[BobKamman]

That's interesting, IRS seems to have adopted the attitude of "if we can't trust you to know the $750K limit, we can't trust you on anything.  How do we know the loan wasn't taken out for a trip to Monte Carlo?"  So I think you're on the right track with the closing statement, especially if the address is the one on the tax return.  And I would include a signed taxpayer statement that the loan is on a qualifying residence.  

When you write "they sent a response," what did they ask for in the first one, and what were they sent?

[sjrcpa]

I'm actually surprised they caught this, but pleasantly.

One year, when the limit was $1 million + $100,000, and we applied the limits correctly for my client's $2.5 million mortgage, he got audited. We had to provide the closing statement, the loan agreement, and since he had the house built, the construction contract. There was probably some other stuff, too.

[lefty]

Great question (my first question to the client).

They sent the closing statement from home purchase, the mortgage interest limitation worksheet, and the 1098.

[abctax55]

From a similar post on the Spidell message board:

• I had that happen because the interest was high compared with their income. You need to show receipts for the payments showing that you made them and not someone else. The 1098 shows it was paid but not who paid it. How were the payments made?

• May 29, 2023 at 5:22 pmREPLY

  My client is currently in tax court regarding this issue. We have furnished the Form 1098s, mortgage documents, calculated the allowable mortgage (>750K). We had sent all this information to the IRS in NY in several letters, and had the mortgage interst disallowed. Our recalulations have approximate 5K disallowed and not the entire amount per IRS NY.

• May 30, 2023 at 5:13 amREPLY

  Payments were made by automatic withdrawal from bank account.  Thank you for responses.  Why doesn’t the IRS say what they want to settle the issue (copies of bank statements?).  I am waiting to hear from the taxpayer advocate but will have the client prepare the bank statements to show they paid the mortgage.  The limit on the mortgage amount was grandfathered and that was all explained in the initial response to the disallowance.

• May 30, 2023 at 9:06 amREPLY

  “Why doesn’t the IRS say what they want to settle the issue (copies of bank statements?).”

  Because you don’t know that what they want is bank statements.

  No where in this thread have you established that the issue is the IRS dis-believing that the payments were made.  The IRS referenced in their notice whether or not the deduction was allowed by law. Providing bank statements does absolutely nothing to establish that.

  You have not addressed any of the other possibilities, such as interest on debt over the allowed acquisition debt limit, or amount of payments made (including principal) that don’t leave enough income left over to reasonably cover other support costs, or 1098 issued to a co-owner of the property, or whether the property securing the mortgage is an eligible property, or any of a number of other reasons why the mortgage interest might not be fully deductible.

  Granted, you should be able to get a response as to why they think the payments are not deductible, but simply sending bank statements probably won’t accomplish anything IMO.