8037 / Can a taxpayer deduct mortgage interest overcharges that are later reimbursed?

Editor’s Note: The 2017 tax reform legislation changed the rules governing the treatment of mortgage interest, home equity indebtedness interest and interest on debts to secure refinancing. See Q 8034 for details.

Taxpayers generally are not permitted a deduction for an interest payment made on a debt for which no liability exists or reasonably appears to exist. However, if a taxpayer in good faith makes an interest payment on an adjustable rate mortgage (ARM), and a portion of the interest is later determined to have been erroneously charged, the taxpayer is permitted under IRC Section 163(a) to deduct the interest overcharge in the year paid. The taxpayer’s recovery of the overcharge is includable in the taxpayer’s gross income in the year of recovery, but only to the extent that the prior deduction of the overcharge reduced the taxpayer’s income tax in a prior tax year. This result is the same whether the lender refunds the overcharge or reduces the outstanding principal on the taxpayer’s mortgage by the amount of the overcharge.¹

1. Rev. Rul. 92-91, 1992 CB 49.