Final Regs. Explain Allocation of Deduction for Prepaid Mortgage Insurance Premiums

The IRS on Friday issued final regulations governing the allocation of prepaid mortgage insurance premiums for periods after Dec. 31, 2010 (T.D. 9588). The final regulations adopt rules that were issued as proposed and temporary regulations in 2009 (T.D. 9449; REG-107271-08).

The deduction under Sec. 163(h)(3)(E) for mortgage insurance premiums, enacted in the midst of the worst days of the economic crisis, applies to mortgage insurance premiums paid between Jan. 1, 2007, and Dec. 31, 2011, or to amounts properly allocable to periods before Dec. 31, 2011 (Sec. 163(h)(3)(E)(iv)). Under Sec. 163(h)(4)(F), prepaid qualified mortgage insurance premiums that are properly allocable to periods after the close of the tax year must be treated as paid in the period to which they are allocable.

Under new Regs. Sec. 1.163-11(a)(1), an individual who pays a mortgage insurance premium that is properly allocable to a mortgage that extends beyond the year in which it was paid must allocate the premium over the shorter of (1) the mortgage’s stated term, or (2) 84 months, beginning with the month the insurance was obtained. The deduction for prepaid mortgage interest applies whether the payment was made in cash or financed (Regs. Sec. 1.163-11(b)). If a mortgage is satisfied before the end of its stated term, no deduction is allowed after that period (Regs. Sec. 1.163-11(a)(2)).

Under Regs. Sec. 1.163-11(b), the allocation requirement applies to mortgage insurance provided by the Federal Housing Administration and private mortgage insurance (defined in 12 U.S.C. §4901) but not to mortgage insurance provided by the Department of Veterans Affairs or the Rural Housing Service.

The final regulations apply to prepaid qualified mortgage insurance premiums paid or accrued on or after Jan. 1, 2011. The treatment of mortgage insurance premiums as interest described in the final regulations is limited to prepaid qualified mortgage insurance premiums that are paid or accrued on or after Jan. 1, 2011, and during periods to which Sec. 163(h)(3)(E) is applicable. Thus, unless Congress again extends the effective date of Sec. 163(h)(3)(E), the regulations will not be effective for premiums paid or accrued after Dec. 31, 2011.