Contributed by: Henry, FreeTaxUSA Agent, Tax Pro
The FreeTaxUSA software is limiting your mortgage interest deduction because the two 1098 forms you’ve entered show combined balances over $750,000. This doesn’t seem right! How can you claim the maximum deduction? Don’t worry; we’re here to help. Let’s start by looking at how the mortgage interest deduction works.
Form 1098
If you took out a loan to buy a home, your lender will generally send you a Form 1098 at the end of each year. This form reports mortgage interest and points paid by you, which are used to claim the mortgage interest deduction. However, the deduction may be limited depending on your total mortgage debt, your filing status, and when you took out your loan(s).
Mortgage interest deduction limits
According to the IRS, you can deduct home mortgage interest on the first $750,000 ($375,000 if married filing separately) of indebtedness. The limit is $1 million ($500,000 if married filing separately) if you’re deducting mortgage interest from indebtedness incurred prior to December 16, 2017.
Before claiming a deduction, you need to figure the average balance of each mortgage for the year using one of the methods described in IRS Publication 936. If your overall average mortgage balance exceeds the applicable limit, you should only deduct the interest on the portion of the debt up to the limit. FreeTaxUSA makes this process easy (for 2024 and later years), helping you calculate your average mortgage balance and then applying the appropriate limit based on the information you provide about your mortgage(s).
Example #1: Amanda took out a $950,000 loan to buy her main home in 2022. During 2024, her average mortgage balance for the loan was $887,000. On her 2024 tax return, Amanda can only deduct the mortgage interest paid on $750,000 of the loan; the interest paid on the remaining $137,000 is not deductible.
Two 1098 forms
If you refinanced during the year or if another bank or lender bought the mortgage from the original lender, you should receive two 1098 forms for the same property: one from the original mortgage or lender and one from the new mortgage or lender for after the refinance or sale of the mortgage.
Example #2: Kayden took out a $550,000 loan with Bank A to buy his main home on April 12, 2020. On June 1, 2024, Bank A sold his outstanding mortgage of $460,000 to Bank B. Kayden received a 2024 Form 1098 from Bank A with $478,000 in Box 2 (the amount of outstanding principal on the original mortgage as of January 1, 2024). He also received a 2024 Form 1098 from Bank B showing $460,000 in Box 2 (the outstanding mortgage principal as of June 1, when the loan was acquired by Bank B).
Reporting two forms for the same mortgage may make it seem as if your total indebtedness is more than it is, potentially subjecting you to deduction limits that shouldn’t apply to your situation. Using our example, the amounts in Box 2 on Kayden’s 1098s add up to $938,000, but he doesn’t actually have $938,000 of debt.
In a situation like this, it’s important to enter the 1098 information correctly in the FreeTaxUSA software, so the total mortgage debt isn’t overstated and your ability to deduct the full amount of your mortgage interest isn’t limited unnecessarily.
Entering the 1098s in FreeTaxUSA
To enter your 1098 information:
- Follow the menu path: Deductions/Credits > Itemized Deductions > Homeowner Expenses (1098) > I have a 1098 > + Add 1098 Mortgage Interest.
- Enter the information for the 1098 from the original lender.
- Answer Yes to the question that asks if the mortgage was refinanced or sold to another lender.
- You’ll come back to the “Your Mortgage Interest (Form 1098)” screen. Choose to add another 1098. Then enter the second 1098 form for the refinanced mortgage or the new mortgage.
- For this 1098, answer No to the question that asks if the mortgage from this lender was refinanced or sold to another lender.
- Continue until you reach a page that says, “Tell us more about each loan shown below.”
- For the first mortgage lender, the loan balance as of January 1 of the following year should be $0. For the second mortgage lender, you should refer to your loan statement to determine your loan balance as of January 1 of the following year.
- The purchase date is the date you purchased your home and would typically be the same for both lenders if your mortgage was refinanced or sold to another lender.
- Next, you’ll be asked to confirm your average mortgage balance. The FreeTaxUSA software will calculate your average mortgage balance using the first and last balance method and will provide a suggested amount. However, you can use another method to do the calculation on your own if you’d prefer.
- The software will calculate how much of your mortgage interest is deductible. In our example, the average mortgage balance of $451,000 is below the $750,000 limit, so Kayden’s mortgage interest is fully deductible.
By following these steps to report your mortgage interest, you’ll maximize your deduction while ensuring compliance with tax regulations.