Home Mortgage Interest Deduction: Despite Challenges Presented by Complex Tax Rules, IRS Could Enhance Enforcement and Guidance
Published: 2009-07-29T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: The home mortgage interest deduction is the third most expensive federal income tax expenditure, with the government expected to forgo about $80 billion of revenue for the deduction in 2009.1 Subject to various limitations, taxpayers may deduct interest on home-secured loans, such as mortgages, mortgage refinancings, and home equity loans, including those taken as lump sum amounts and home equity lines of credit. The rules that taxpayers must follow in determining the proper amount of mortgage interest to deduct can be complex. For example, there are limitations on the amount of debt for which interest can be deducted, special rules for refinancing, situations where alternative minimum tax (AMT) considerations apply, and rules on the deductibility of prepaid interest amounts called points. In general, complex tax rules increase the potential for noncompliance. Congress asked us to study the home mortgage interest deduction to determine if there are administrative issues that need to be addressed to improve taxpayer compliance and Internal Revenue Service (IRS) enforcement. For this report, we (1) provide information on how IRS detects taxpayers' noncompliance with the home mortgage interest deduction rules and what it knows about the extent of noncompliance; (2) identify the problems, if any, taxpayers face in attempting to comply with the deduction and describe IRS's challenges in detecting mortgage interest deduction noncompliance; (3) assess options to give IRS more information to enforce compliance with the rules; (4) determine whether IRS's guidance to taxpayers and its examiners' guidance and training on the deduction provide enough information to properly calculate the taxpayers' allowable mortgage interest deduction; and (5) describe how tax-return preparation software programs handle the deduction. Congress also asked us to provide descriptive information on taxpayers' mortgage interest deductions and mortgage interest payments reported on Form 1098, Mortgage Interest Statement. Appendix V provides this information. Consideration of statutory changes was beyond the scope of our report.
section_title: What GAO Found
paragraphs: Although IRS's enforcement and research programs found some mortgage interest deduction compliance problems, the methods leave gaps in what is known about the extent and specific nature of noncompliance. The four main programs that IRS uses to enforce or research mortgage interest deduction compliance include the following. (1) A computer matching program designed to identify taxpayers whose mortgage interest deduction exceeds amounts reported on Form 1098; (2) IRS's National Research Program (NRP), the main ongoing study of taxpayer compliance based on examinations of a random sample of tax returns; (3) Routine examinations done by correspondence, in an IRS office, or on site; and (4) Two special compliance initiative projects (CIP) primarily examining acquisition debt for a limited segment of individual taxpayers with high mortgage interest deductions or high adjusted gross incomes. The mortgage interest deduction rules create compliance problems for taxpayers, reflecting the deduction's complexity. The effects of the problems, however, are uneven. Although many taxpayers might encounter few problems, others could face many more. Problems cited by tax practitioners and in our review of articles on deducting home mortgage interest included the following: (1) Taxpayers need to distinguish between acquisition and home equity debt but did not always do so. (2) Taxpayers deducted interest on loans exceeding the limitations, including the acquisition, home equity, and two-home limits. (3) Taxpayers who were subject to the AMT and thus not eligible to deduct home equity interest claimed it nonetheless. (4) Tax practitioners also missed the limitations and did not comply with the AMT rules. (5) Depending on the circumstances, some taxpayers and practitioners faced extensive recordkeeping and calculations related to such matters as refinancing, the AMT, business use of the home, other uses of loan proceeds, and the periodic use and repayment of home equity lines of credit. (6) Taxpayers may have been unaware that they might need documentation on matters such as how proceeds of home equity loans are spent to properly determine the amount of the mortgage interest deduction on their tax returns. (7) Mortgage interest deduction limits based on debt amounts are not directly comparable with the information on Form 1098, which lists interest paid. If taxpayers' debts exceed the limits, taxpayers must calculate how much interest they can deduct. Additional information about taxpayers' mortgages could help IRS identify the most productive cases to examine and determine whether taxpayers are claiming the correct amount of mortgage interest deduction. IRS could obtain more helpful information about taxpayers' mortgages by expanding information collected on Form 1098. IRS officials said that in implementing certain additional reporting requirements, the agency would need to meet the terms of the Paperwork Reduction Act, which requires agencies to minimize the paperwork burden they impose on the public and maximize the practical utility of the information they collect. Taken as a whole, IRS taxpayer guidance--Schedule A and its instructions, Publication 17, Your Federal Income Tax, and Publication 936, Home Mortgage Interest Deduction--generally informed taxpayers that mortgage interest deductions are subject to limits. Even though the guidance was generally sufficient, Schedule A does not explicitly mention the limitations. IRS's examiners' guidance and training materials included information for identifying and calculating home-equity and the acquisition-debt limitations. Overall, examiners we interviewed were satisfied with training and guidance on the mortgage interest deduction. The three companies' tax preparation software for individuals that we analyzed differed from each other in how they treated the limitations on the amount of debt for which interest can be deducted.

section_title: Letter
paragraphs: The home mortgage interest deduction is the third most expensive federal  income tax expenditure, with the government expected to forgo about $80  billion of revenue for the deduction in 2009.  Subject to various  limitations, taxpayers may deduct interest on home-secured loans, such as  mortgages, mortgage refinancings, and home equity loans, including those  taken as lump sum amounts and home equity lines of credit.
The rules that taxpayers must follow in determining the proper amount of  mortgage interest to deduct can be complex. For example, there are  limitations on the amount of debt for which interest can be deducted,  special rules for refinancing, situations where alternative minimum tax  (AMT) considerations apply, and rules on the deductibility of prepaid  interest amounts called points. In general, complex tax rules increase the  potential for noncompliance.
You asked us to study the home mortgage interest deduction to determine  if there are administrative issues that need to be addressed to improve  taxpayer compliance and Internal Revenue Service (IRS) enforcement. For  this report, we (1) provide information on how IRS detects taxpayers’  noncompliance with the home mortgage interest deduction rules and what  it knows about the extent of noncompliance; (2) identify the problems, if  any, taxpayers face in attempting to comply with the deduction and  describe IRS’s challenges in detecting mortgage interest deduction  noncompliance; (3) assess options to give IRS more information to enforce  compliance with the rules; (4) determine whether IRS’s guidance to  taxpayers and its examiners’ guidance and training on the deduction  provide enough information to properly calculate the taxpayers’ allowable  mortgage interest deduction; and (5) describe how tax-return preparation  software programs handle the deduction. You also asked us to provide  descriptive information on taxpayers’ mortgage interest deductions and  mortgage interest payments reported on Form 1098, Mortgage Interest  Statement. Appendix V provides this information. Consideration of  statutory changes was beyond the scope of our report.
To address our objectives, we analyzed IRS’s efforts to determine taxpayer  compliance with the mortgage interest deduction. This included examining  information on IRS’s compliance initiative projects that focused on the  deduction and on IRS’s other routine examination activities.  We also  analyzed information from IRS’s Statistics of Income (SOI) Division and  Compliance Data Warehouse (CDW) databases to compile information  about individuals’ year-to-year changes in claiming the deduction and  obtained statistical information from the private sector on home equity  loans, home equity lines of credit, and refinancings. We reviewed relevant  studies and publications and interviewed cognizant IRS officials and  representatives from the tax preparation and mortgage banking industries  to obtain information on the issues surrounding administration of the  deduction.
We determined whether IRS’s guidance to taxpayers prominently  mentioned the limitations on the amount of debt for which interest can be  deducted. To determine whether IRS examiners’ training and guidance  provided enough information on properly calculating the mortgage  interest deduction, we compared IRS’s examination training and guidance  with tax law and instructions. We also analyzed how several tax  preparation software packages that are widely used by individual  taxpayers or paid preparers handled the calculation of the deduction by  reviewing appropriate parts of the software to determine how they treated  the debt limitations and by interviewing company officials. We performed  tests that determined the data used in this report were reliable for our  purposes. Appendix I provides a more detailed discussion of our scope  and methodology.
We conducted this performance audit from May 2008 through July 2009 in  accordance with generally accepted government auditing standards. Those  standards require that we plan and perform the audit to obtain sufficient,  appropriate evidence to provide a reasonable basis for our findings and  conclusions based on our audit objectives. We believe that the evidence  obtained provides a reasonable basis for our findings and conclusions  based on our audit objectives.
subsections: section_title: Background
paragraphs: Taxpayers have been allowed to deduct mortgage interest payments on  their federal tax returns since Congress enacted the federal income tax in  1913. At that time, the deduction for home mortgage interest was part of  the deduction allowed for any interest paid. The Tax Reform Act of 1986  limited deductions for nonbusiness interest.  The 1986 act specifically  disallowed deductions by individuals of personal interest but included a  limited exception for qualified mortgage interest. The 1986 act was  amended the next year to include dollar limits on the amount of home  mortgage debt for which interest payments can be deducted.
Taxpayers may deduct the interest they pay on loans secured by qualified  homes—either their main home or their main home and a second home.  These loans include first or second mortgages, home equity loans, and  home equity lines of credit. Boats and recreational vehicles may qualify as  homes if they have sleeping, cooking, and toilet facilities.
As table 1 shows, two kinds of debt may qualify for the mortgage interest  deduction. The first kind is acquisition debt, which is debt incurred in  acquiring, constructing, or substantially improving a qualified home and  that is secured by the home. Taxpayers may deduct all of the interest paid  on acquisition debt incurred on or before October 13, 1987, known as  grandfathered debt. Taxpayers’ interest deductions for debt on qualified  homes purchased after October 13, 1987, is limited to the interest on $1  million of acquisition debt, reduced by any grandfathered debt.
The second kind of qualified debt is home equity debt, which is any non- acquisition debt secured by the home. Its proceeds may be used for  anything other than to buy, build, or substantially improve the home. For  example, the proceeds may be used to pay off credit cards or finance cars  or vacations. Home equity debt is limited to the home’s fair market value  minus the acquisition debt and grandfathered debt, or to $100,000,  whichever is less. Home equity debt for tax purposes should not be  confused with what is commonly called a home equity loan. The latter may  qualify as either acquisition debt or home equity debt depending on how  the proceeds are used.
Table 1 also summarizes the deductibility of points. A point is a term used  to describe certain charges paid in connection with obtaining a mortgage  and is calculated at 1 percent of a mortgage’s principal. Generally, points  are considered prepaid interest, and, as such, the deduction is usually  allocated over the life of the loan. However, if various conditions are met,  the taxpayer may deduct the points in the year paid.   Determining  whether points are fully deductible in the year paid may require that  taxpayers go through as many as 10 decision steps.
Lending institutions and other entities engaged in a trade or business that  receive $600 or more during the year in mortgage interest and certain  points from an individual taxpayer are required to file a Form 1098,  Mortgage Interest Statement. Form 1098 reports are sent both to the  taxpayer and IRS to show how much mortgage interest was paid to the  lender that year.
Taxpayers report their deductible mortgage interest information to IRS on  lines 10 through 13 of Schedule A, the schedule itemizing deductions for  the Form 1040 individual income tax return (see app. II). Typically, the  larger deductible amounts are reported on line 10, which shows home  mortgage interest and points reported to taxpayers on Form 1098. Lines 11  and 12 of Schedule A are for claiming mortgage interest and points,  respectively, not reported on Form 1098, and, starting in 2007, line 13 is  used for deductible qualified mortgage insurance premiums. Some interest  payments reported on Form 1098 may be deductible on other Form 1040  schedules, such as Schedule C for sole proprietorship businesses or  Schedule F for farming.
Changes in the housing market over the years may have affected the  overall amount of home mortgage interest that taxpayers claimed. Table 2  shows the change in various indicators related to the mortgage interest  deduction from 2001 to 2006. The rise in home prices and thus mortgage  amounts, partly account for the large increases in mortgage interest  deductions claimed by taxpayers in 2006 compared to 2001. In 2006, the  median sales price for existing U.S. single-family homes was up from 2001.  Median sales prices varied widely across metropolitan areas, with some  locations exceeding $700,000. The home equity loan totals reported by the  Federal Reserve Board also increased significantly from 2001 to 2006.  According to the U.S. Census Bureau’s 2006 American Community Survey,  about a fifth of owner-occupied housing units with a mortgage had a home  equity loan. Also, according to the Joint Center for Housing Studies of  Harvard University, 85 percent of homeowners who refinanced their  mortgages in 2006 took cash out.
section_title: IRS’s Enforcement and Research Programs Do Not Provide an Overall Picture of Mortgage Interest Deduction Noncompliance
paragraphs: Although IRS’s enforcement and research programs found some mortgage  interest deduction compliance problems, the methods leave gaps in what  is known about the extent and specific nature of noncompliance. The four  main programs that IRS uses to enforce or research mortgage interest  deduction compliance include the following.
A computer matching program designed to identify taxpayers whose  mortgage interest deduction exceeds amounts reported on Form  1098: Of the approximately 1.7 million mismatches the program  identified above a certain threshold in 2005, the latest year available,  IRS followed up on about 135,000 and changed tax assessments or  refunds for about 53,000.  Tax assessments totaled about $216 million,  much more than in previous years, and averaged about $4,300.
IRS’s National Research Program (NRP), the main ongoing study of  taxpayer compliance based on examinations of a random sample of  tax returns: IRS found that between 12 and 14 percent of individual  taxpayers who claimed home mortgage interest on line 10 of Schedule  A misreported the amount. The misreporting was split about evenly  between taxpayers underreporting the deduction and taxpayers  overreporting it.
Routine examinations done by correspondence, in an IRS office, or  on site: IRS does not maintain separate examination results solely on  line 10 issues. Most of the approximately 33,000 examinations done in  fiscal year 2008 by IRS revenue agents and tax compliance officers that  included a review of line 10 resulted in increases to the line 10  deduction (i.e., the deduction increased) or in no recommended  change. For cases involving line 10 where examiners recommended  greater tax amounts, the median tax owed for all issues examined  including line 10 was $4,612, according to our analysis of IRS records.  For cases closed in fiscal year 2008 in which examiners decreased the  line 10 amounts and lowered taxpayers’ deductions, the median  decrease in the line 10 mortgage interest deduction was $6,430. Other  results are listed in appendix III.
Two special compliance initiative projects (CIP) primarily  examining acquisition debt for a limited segment of individual  taxpayers with high mortgage interest deductions or high adjusted  gross incomes: About 9,000 examinations were closed in fiscal year  2008 for both projects. IRS recommended about $95 million in tax  changes for cases closed in fiscal years 2006 through 2008. Examiners  decreased line 10 deductions for most cases closed in fiscal year 2008.  The median decreases were about $29,000 for the first project and  $28,000 for the second. For cases in which examiners increased the tax  owed, the median increases in tax were about $8,000 in both projects.  IRS examiners attributed the changes to taxpayers and paid tax return  preparers not knowing or ignoring the mortgage interest deduction  rules and to problematic tax preparation software. Appendix III also  presents results from CIP exams.
Table 3 shows, for these four main programs, that gaps exist in what IRS  can measure or enforce concerning taxpayers’ mortgage interest  deductions.
Of the four main programs, only NRP projects the amount of mortgage  interest deduction misreporting to the population of individual taxpayers.  However, because NRP automatically excluded any Schedule A deduction  where the Form 1098 amounts matched the Schedule A amounts, it may  have underestimated mortgage interest deduction misreporting relating to  the home equity and acquisition debt limits.
section_title: Taxpayers Face a Variety of Problems Trying to Comply with Mortgage Interest Deduction Rules, and IRS Faces Challenges in Detecting Noncompliance
paragraphs: The mortgage interest deduction rules create compliance problems for  taxpayers, reflecting the deduction’s complexity. The effects of the  problems, however, are uneven. Although many taxpayers might  encounter few problems, others could face many more. Problems cited by  tax practitioners and in our review of articles on deducting home  mortgage interest included the following:    Taxpayers need to distinguish between acquisition and home equity  debt but did not always do so.
Taxpayers deducted interest on loans exceeding the limitations,  including the acquisition, home equity, and two-home limits.
Taxpayers who were subject to the AMT and thus not eligible to deduct  home equity interest claimed it nonetheless.
Tax practitioners also missed the limitations and did not comply with  the AMT rules.
Depending on the circumstances, some taxpayers and practitioners  faced extensive recordkeeping and calculations related to such matters  as refinancing, the AMT, business use of the home, other uses of loan  proceeds, and the periodic use and repayment of home equity lines of  credit. One practitioner told us that completing worksheets was the  quick and easy part of work related to the mortgage interest deduction;  the most difficult and most time-consuming part was getting taxpayers  to locate and provide the proper information on what kind of debt was  involved and how loan proceeds were used. Typically, taxpayers  provided records piecemeal over time and after many phone calls.
Taxpayers may have been unaware that they might need  documentation on matters such as how proceeds of home equity loans  are spent to properly determine the amount of the mortgage interest  deduction on their tax returns.
Mortgage interest deduction limits based on debt amounts are not  directly comparable with the information on Form 1098, which lists  interest paid. If taxpayers’ debts exceed the limits, taxpayers must  calculate how much interest they can deduct.
The complexity of the laws that govern the mortgage interest deduction  are evident in the guidance IRS has published. Figure 1 is the flowchart in  IRS’s 16-page instructions to taxpayers—Publication 936: Home Mortgage  Interest Deduction—that help taxpayers determine if their mortgage  interest is fully deductible.  It leads taxpayers through as many as seven  decision points and still sometimes requires them to consult another part  of the publication. Appendix IV provides two examples of the mortgage  interest deduction’s complexity.
subsections: section_title: Addressing Compliance Problems and Complexity Would Likely Require Policy Changes
paragraphs: To alleviate the problems and complexity facing taxpayers complying with  the mortgage interest deduction rules, policy makers likely would have to  change tax laws. For example, we noted in the past that shifting mortgage  interest deduction limits from debt amounts to an interest-limit cap could  simplify administration of the deduction. Under an interest-limit cap, IRS  could more easily compare the amounts reported on Schedule A and Form  1098 to the cap and identify cases for audit or follow-up. Similarly,  taxpayers would have only to report the amount of Form 1098 interest that  fell under the cap and would not have to figure out which property  qualified or how to account for debt limits, depending on how any new  legislation was written.
However, changing the tax code for qualified residential mortgage interest  deductions could have significant tax policy implications. For example, an  interest-paid cap could cause taxpayers living in areas with high housing  prices to be disadvantaged compared with taxpayers with similar incomes  living in areas with low housing prices. A cap could also disadvantage  those who borrowed during periods of high interest rates. Assessing such  policy changes and whether such consequences would be appropriate are  beyond the scope of this report.
section_title: Because Mortgage Interest Reported on Form 1098 Is Not Directly Comparable to Legal Debt Limits, IRS Must Use Costly Methods to Detect Certain Noncompliance
paragraphs: Because the Form 1098 information report shows the dollar amount of  interest a taxpayer paid in a year without regard to the limits on the  amount of debt imposed by law, IRS’s computer matching program  comparing Form 1098 and tax return amounts will not detect certain  noncompliance. For example, as already discussed, taxpayers cannot  claim a deduction for interest exceeding the $1 million acquisition debt  limit or other limitations. However, the annual information report for a  taxpayer with a $1.5 million acquisition mortgage would show the interest  paid on the entire mortgage instead of the interest on the $1 million under  the annual debt limit. Because of this, the information IRS receives from  third parties on Form 1098 cannot be used by itself to determine if  taxpayers improperly claimed interest on debt in excess of the legal  limitations.
However, the way to overcome this problem—using examinations to  detect noncompliance—is expensive compared to automated matching  programs, and its payoff in increased revenue is low. For example,  according to IRS examiners, pinpointing which tax returns have a home- equity debt noncompliance issue is very labor intensive.
As shown earlier, for non-CIP line 10 examinations by revenue agents and  tax compliance officers closed in fiscal year 2008, the median decrease to  line 10 was $6,430, according to our analysis of IRS data. At the highest  individual tax rate of 35 percent and assuming no offsetting factors, the  resulting increase in tax revenue would be about $2,250. Although not an  exact comparison, the average tax assessment IRS recommended for field  examinations of individual taxpayers was about $19,150 per taxpayer.  Given the non-CIP examinations’ relatively low payoff, some practitioners  we interviewed said the tax code as it relates to the home mortgage  interest deduction is unenforceable in a practical sense.
section_title: Options Exist for Expanding Mortgage Information Reporting and Using Private Sector Data to Enhance Enforcement
paragraphs: Additional information about taxpayers’ mortgages could help IRS identify  the most productive cases to examine and determine whether taxpayers  are claiming the correct amount of mortgage interest deduction. IRS could  obtain more helpful information about taxpayers’ mortgages by expanding  information collected on Form 1098. IRS officials said that in  implementing certain additional reporting requirements, the agency would  need to meet the terms of the Paperwork Reduction Act, which requires  agencies to minimize the paperwork burden they impose on the public and  maximize the practical utility of the information they collect.
IRS officials also said attention would need to be paid to the added costs  that expansion would impose on third parties and IRS, such as updating  computer systems. Any computer programming changes for IRS and third  parties would likely be done only once to accommodate the new  information.
Form 1098 could be revised to collect the following information:     address of the property secured by the mortgage to which the interest  on the form relates;   outstanding mortgage debt balances on the property;     an indicator if the mortgage interest is for a loan that was refinanced  during the year; and     an indicator of whether the mortgage interest relates to an acquisition  loan or a home equity loan.
Figure 2 shows what a Form 1098 might look like if revised to collect any  of this information. We found that some companies that submit Form 1098  statements to IRS already provide some of this information with the Form  1098 statements they send to borrowers. These options could be  considered singly or in combination. Further, changes to Form 1098  reporting requirements would need to apply only to future reports to give  filers sufficient time to adjust their computer systems to collect and  calculate the additional information.
subsections: section_title: Adding the Address of Mortgaged Property to Form 1098
paragraphs: If the address relating to taxpayers’ mortgage interest deductions were on  the Form 1098 (see fig. 2, box 6) and electronically captured in IRS  databases, IRS could use an automated process to determine whether the  mortgage interest taxpayers claimed corresponded to a qualified residence  and was eligible for the deduction. For example, IRS could see if an  address reported on Form 1098 matched the address that the taxpayers  listed on their Form 1040.  Tax preparers told us that requiring the  property address also would help them prepare returns more accurately  because they could use the information to determine if the property  securing the debt is the taxpayer’s qualified home. Some IRS officials  responsible for examination policy whom we interviewed agreed the  property address would be useful in selecting returns for examination and  in cases where taxpayers have more than one home.
We previously recommended that IRS revise Form 1098 to collect the  address of the property whose mortgage is reported on Form 1098. In  response, IRS agreed to consider implementing our recommendation,  citing the burden the requirement could place on third parties.  Representatives of the mortgage banking industry told us that it would be  feasible to report property address information on Form 1098 because  mortgage lenders already maintain this information. We also found an  example of a lender that provided address information with Form 1098  information that it sent to borrowers.
section_title: Adding Mortgage Balance Information to the Form 1098
paragraphs: If the beginning and ending mortgage debt balances or average annual  debt balances were provided on Form 1098, IRS could electronically  identify taxpayers with more than $1 million in mortgage debt (see fig. 2,  box 7) or identify taxpayers whose mortgage interest deductions appeared  out of proportion to their debt amounts. IRS officials said that debt  balance information would be particularly helpful in selecting returns for  examination if combined with the address information because the  additional information would help disentangle mortgage interest  deductions of taxpayers with multiple homes.
According to a mortgage industry representative, Form 1098 filers could  provide debt balance information. We found examples of companies that  provided information on mortgage balances on the Form 1098 statements  they sent to borrowers. However, industry representatives further stated  that companies do not necessarily have accurate balance information at a  particular point in time and that average balances would be easier for the  industry to report than balances pegged to any specific day, especially for  home equity lines of credit. For companies that do not keep average  balance information now, they would incur the associated set-up costs of  collecting the information in the future.
section_title: Adding a Check Box to the Form 1098 to Indicate Refinancing
paragraphs: Form 1098 could be redesigned with a check box for filers to show  whether a mortgage was refinanced (see fig. 2, box 8). This would help IRS  identify taxpayers who might be noncompliant with rules specific to  refinancing, such as the rule to amortize points paid on the mortgage. A  mortgage industry representative said that the burden of a refinancing  check box could be reduced if the rule were only to complete the box in  the year that the loan was made, eliminating the need for a Form 1098 filer  to track over time whether a refinancing had occurred. Also, Form 1098  filers do not uniformly keep any indication in their records as to whether  loans are acquisition loans or refinancing. However, because the  deductibility of the interest on the cash taken out in a refinancing depends  in part on how the money is spent, identifying refinancing would not  necessarily eliminate the need for IRS to examine returns.
It also would be helpful to IRS if Form 1098 filers could show whether  cash was taken out in a refinancing, but such a change might not be able  to include the amount of cash. The mortgage industry representative said  that any information on the cash taken out would be unreliable and  burdensome for Form 1098 filers to get. Form 1098 filers have estimates  on cash taken out, not the final figures available to the closing agent. The  industry representative also said that Form 1098 filers do not maintain  information on whether loan proceeds exceeded the amount of the loan  that was refinanced. However, IRS examiners could more easily see if  cash were taken out at refinancing and investigate whether rules on  refinancing were followed if Form 1098 had address, mortgage debt, and a  refinancing check box, because they could see whether increases in the  loan balances over time for a particular home took place.
section_title: Adding an Indicator to the Form 1098 to Distinguish between Home Equity and Acquisition Debt
paragraphs: Tax forms do not require taxpayers or Form 1098 filers to report the types  of debt on which mortgage interest deductions are based, even though the  mortgage debt limitations for deducting interest are different for  acquisition and home equity debt. If Form 1098 filers were required to  identify the type of debt associated with the deduction (see fig. 2, box 9),  IRS might more easily discern whether a taxpayer’s deduction exceeded  the acquisition or home equity debt limit, especially if combined with  reports of the debt amounts. Having Form 1098 filers identify debt types,  however, would create challenges. A mortgage industry representative  told us that Form 1098 filers do not always have information about debt  types, especially if the loans have been sold and re-sold or the original loan  has been refinanced. Form 1098 filers do not know whether mortgage  refinancing proceeds were used for home improvements, which could  qualify as acquisition debt or home equity debt, depending on how the  money was used. The representative also said that if a home-equity debt  reporting requirement were instituted, the industry would have to  introduce costly and burdensome systems.
section_title: Private Sector Data Might Be Useful to IRS in Detecting Mortgage Interest Noncompliance
paragraphs: IRS already contracts with a private firm to obtain information about  taxpayers for routine examination purposes. Other private sector data  might also be useful to IRS in detecting mortgage interest noncompliance.  For example, we obtained information from SMR Research, one of several  companies that analyze loan information that IRS might find useful in  determining taxpayer compliance with rules governing the deduction of  interest on home equity loans.
By comparing homeowners’ current mortgage debt for a particular  property with earlier debt, SMR Research estimated that up to several  million homeowners had loans that might have exceeded the home equity  debt limitation. In the aggregate, these homeowners’ debts over the debt  limitation were several hundred billion dollars.  SMR Research’s data do  not show whether taxpayers correctly reported deductions based on home  equity loans. IRS would still have to check the returns. Given information  underlying the transactions in SMR Research’s database and shown in  appendix VII, IRS could test the use of this or similar private-sector  databases to:    pinpoint taxpayers for examination,   initiate correspondence to taxpayers, or    conduct outreach to paid preparers.
Some IRS CIP examiners told us they had significant findings related to  home equity debt, indicating that follow-up might be productive.
section_title: IRS’s Guidance to Taxpayers and Training Materials for Examiners Did Not Indicate the Range of Possible Mortgage Interest Deduction Situations
paragraphs: Taken as a whole, IRS taxpayer guidance—Schedule A and its  instructions, Publication 17, Your Federal Income Tax, and Publication  936, Home Mortgage Interest Deduction—generally informed taxpayers  that mortgage interest deductions are subject to limits. Even though the  guidance was generally sufficient, Schedule A does not explicitly mention  the limitations. As shown in appendix II, Schedule A, line 10 asks  taxpayers for the “Home mortgage interest and points reported to you on  Form 1098.”  Sometimes, as when an acquisition loan exceeds $1 million,  this wording could be problematic because a taxpayer or preparer would  need to look beyond the Form 1098 to determine the proper line 10  amount.  Using the same amount of space on Schedule A as now, line 10  could easily be revised to mention limitations by deleting “reported to you”  and using wording such as “Unless limited, home mortgage interest and  points on Form 1098.”  Another way to revise Schedule A would be to  add something about mortgage interest deduction limitations to the  margin near line 10.
Other possibilities for changing Schedule A to highlight limitations also  exist, but would entail tradeoffs. For example, a check box could be added  to the Schedule asking taxpayers if either the $1 million or the $100,000  limitation applies to their loans. Making such a change not only would help  taxpayers preparing their own returns but also might prompt paid  preparers to more thoroughly interview their clients. However, with the  mortgage interest deduction, these types of changes would add some  burden to taxpayers whose deductions are not affected by the debt limits.  The effectiveness of such change is also unclear.
Taxpayers might not read IRS guidance when preparing returns. To  counter this possibility but also be mindful of preparation, mailing, and  taxpayer service costs involved, IRS could test whether corresponding  with some taxpayers would cost-effectively reduce misreporting. Added  outreach—through seminars or communications with stakeholders such  as paid preparers, tax return software providers, and industry groups— could communicate key rules and common mistakes and be targeted to  taxpayers, such as those reporting the deduction above a certain level.  Sending correspondence directly to taxpayers also could help inform paid  preparers of rules and common mistakes because the taxpayers would  likely share it with their preparers, according to representatives of the tax  return preparation industry.  IRS has used outreach programs on  mortgage interest deductions in recent years. For instance, IRS’s tax tips  covered deducting refinancing costs.
IRS’s guidance on the acquisition debt limit is inconsistent with a prior tax  court ruling. Currently, Publication 936 guides the taxpayer to treat any  qualified mortgage debt above the $1 million acquisition debt limit as  home equity debt subject to the $100,000 limit, regardless of the loan’s use.  In practice, this means that the taxpayer can deduct the interest on up to  $1.1 million in acquisition debt (treating the amount above $1 million as  home equity debt even if used to acquire the home). However, a 1997 U.S.  Tax Court case ruled that the acquisition debt limit is $1 million and no  additional deduction can be taken above the $1 million limit unless the  taxpayer truly has home equity debt.  One tax software company official  cited the 1997 case as support for the company’s decision to change the  guidance in its software to allow interest deductions only up to $1 million  in acquisition debt, rather than follow the guidance in Publication 936. In  2008, IRS Chief Counsel began reviewing the inconsistency in the debt  limit allowances. However, a completion date for this work is uncertain.
Until IRS completes its determination, taxpayers will calculate their  deductions using different debt limits depending on whether they, their tax  preparers, or their tax software follow the guidance in Publication 936 or  the tax court interpretation. Depending on IRS’s determination, some  taxpayers may not be optimizing their deduction or IRS could be losing  revenue from taxpayers overdeducting.
subsections: section_title: IRS Examiner Guidance and Training Materials Addressed Mortgage Interest Deduction Limitations but Lacked Instructive Examples of Some Relevant Situations
paragraphs: IRS’s examiners’ guidance and training materials included information for  identifying and calculating home-equity and the acquisition-debt  limitations. Overall, examiners we interviewed were satisfied with training  and guidance on the mortgage interest deduction.
However, IRS’s guidance and training materials did not cover problems  that may arise in some real-life situations. For example, the guidance does  not mention a problem that an examiner said she commonly found:  taxpayers owning a third home, waiting to sell one of their first two, and  deducting the interest paid on all three. Neither does the guidance address  situations that tax professionals described as challenging for IRS to  enforce, such as multiple refinancings, mortgages, or home equity lines of  credit.  The absence of such examples could impede examiners who do  not deal with mortgage interest deduction issues regularly. An IRS training  official told us that updating training materials with relevant examples  could be done easily.
Also, IRS’s examiner training materials reflect the taxpayer guidance with  regard to the allowable acquisition debt limit. For example, according to  one IRS training exercise, taxpayers could deduct interest on up to $1.1  million in mortgage debt even if they used the $1.1 million just to acquire a  home, contradicting the 1997 tax court ruling, discussed above. The  difference may lead examiners to inconsistently calculate the tax owed,  because some may calculate the acquisition debt limit as $1 million based  on the tax court determination and others may allow deductions on up to  $1.1 million as instructed by the training. As previously mentioned, IRS  Chief Counsel’s office is reviewing the inconsistency between the IRS  guidance and the tax court ruling. IRS officials said that they have  procedures to ensure that once the review is complete, examiners will be  told of any clarification.
section_title: Tax Software Differed in the Ease of Navigating Mortgage Interest Deduction Instructions
paragraphs: The three companies’ tax preparation software for individuals that we  analyzed differed from each other in how they treated the limitations on  the amount of debt for which interest can be deducted.  These software  packages were among the most widely used by individuals.  One  company’s initial software screen containing mortgage interest deduction  instructions mentioned possible deduction limitations, sending users to  Publication 936 for calculations. One of the other companies made  changes to its mortgage interest deduction displays in its 2008 version  after considering our input on its 2007 version. These changes give more  prominence to the deduction limitations and how Publication 936 may be  used for calculations.
The third company’s on-line software had information on the limitations,  but users would not find this information unless they looked under  “frequently asked questions.”  This software also led the user to take  amounts directly off Form 1098. For 2008, the software added a question  to its frequently asked questions area about what taxpayers should do if  interest and points exceeded the amount they could deduct. If taxpayers  were to click on this question, they would find information about the  limitations and the calculation needed.
IRS does not know how frequently software packages are associated with  misreporting. Such information could help IRS in its compliance efforts.  We recently recommended that IRS require software companies to include  a software identification number that specifically identifies the software  package used to prepare tax returns. IRS plans to implement a software  identification system in October 2009.
section_title: Conclusions
paragraphs: Because IRS has little information on taxpayers’ mortgage debts, it cannot  easily detect when taxpayers are not complying with the deduction limits.  Instead, to ensure taxpayer compliance with the statutory requirements,  IRS must conduct examinations that are more costly to use than other  enforcement methods, such as a matching program. The absence of  specific information about the reasons for noncompliance also prevents  IRS from making efficient decisions on how to select cases for  examination. Simultaneously, the complexity of mortgage interest  deduction rules creates problems with some taxpayers trying to comply.  These problems are compounded by an inconsistency between IRS  guidance and a tax court ruling on acquisition debt limits. Because the  limits causing complexity are written in law, statutory changes may be the  most direct way to address the challenges of administering the deduction  and alleviate the compliance problems. However, consideration of  statutory changes was beyond the scope of this report. Nonetheless,  within the current statutory framework, opportunities exist for IRS to  mitigate some of the problems we identified.
section_title: Recommendations for Executive Action
paragraphs: We are making seven recommendations. Specifically, we recommend that  the Commissioner of Internal Revenue  revise NRP’s case selection system so that a tax return’s mortgage  interest deduction is not automatically excluded as an examination  issue if it matches information reported on Form 1098;   revise Form 1098 to require third parties to provide information on  mortgage balances, the address of a home securing a mortgage, and an  indicator of whether the mortgage is for a current year refinancing; investigate whether using information from private sources would be  productive in detecting mortgage interest noncompliance, especially  for home equity debt; revise the wording on Schedule A to clearly state that the mortgage  interest deduction is subject to limitations;   conduct a test to evaluate whether mortgage interest deduction-related  outreach programs to taxpayers and tax return preparers could be a  cost-effective way to reduce noncompliance; outreach might include  sending correspondence covering key rules and common mistakes or  promoting seminars on common types of misreporting;    set a date to complete the Chief Counsel determination on whether the  acquisition debt limit is $1 million or $1.1 million when used in  combination with the home equity debt limit; and revise examiner training materials by adding examples cited as  common problems by auditors and paid tax return preparers, such as  those involving multiple homes or home-based businesses, and after  the Chief Counsel’s final determination on the acquisition limit, revise  examiner training and the worksheet in guidance to reflect the project’s  outcome.
section_title: Agency Comments and Our Evaluation
paragraphs: We received written comments from the Internal Revenue Service on July  23, 2009 (for the full text of the comments, see app. VIII). IRS agreed with  five of our recommendations and agreed to study the other two. It  acknowledged that without information about taxpayers’ mortgage debts,  it cannot easily detect taxpayer noncompliance with the mortgage interest  deduction limits. IRS also said that the absence of information about  noncompliance prevents it from efficiently deciding how to select cases  for review and that the complexity of the rules causes problems for some  taxpayers. Regarding our recommendation to revise Form 1098 to include  more information on taxpayer mortgages, IRS agreed to study the issue,  saying it does not have enough data to support revisions at this time.  Because IRS acknowledged in its comments that it does not have  information about taxpayers’ mortgage debts to easily detect  noncompliance, we believe that our recommended revisions to Form 1098  would be cost-effective ways to provide IRS with additional useful  information to help it detect noncompliance. Concerning our  recommendation to conduct a test to evaluate whether mortgage interest  deduction-related outreach programs could be a cost-effective way to  reduce noncompliance, IRS said it will study the feasibility of such a test.
As agreed with your office, unless you publicly announce its contents  earlier, we plan no further distribution of this report until 30 days after its  date. At that time, we will send copies to the Secretary of the Treasury, the  Commissioner of Internal Revenue, and other interested parties. This  report will also be available at no charge on GAO’s Web site at  http://www.gao.gov.
For further information regarding this report, please contact me at (202)  512-9110 or at whitej@gao.gov. Contacts for our Offices of Congressional  Relations and Public Affairs may be found on the last page of this report.  Individuals making key contributions to this report may be found in  appendix IX.
section_title: Appendix I: Scope and Methodology
paragraphs: To provide information on how IRS detects taxpayers’ noncompliance  with the home mortgage interest deduction rules and what IRS knows  about the extent of noncompliance and to identify problems, if any, that  taxpayers face in attempting to comply with the deduction and describe  IRS’s challenges in detecting mortgage interest deduction noncompliance,  we    reviewed IRS documents and interviewed agency officials to determine  how IRS checks taxpayers’ compliance with deduction rules and if  there were issues affecting its ability to detect noncompliance. This  included reviewing information on IRS’s compliance initiative projects  that focused on the mortgage interest deduction and interviewing IRS  examiners from four widely dispersed parts of the country who were  involved in the projects. The examiners were selected by IRS officials  for their mortgage interest deduction expertise;    obtained information from IRS’s 2001 National Research Program  (NRP) compliance study of individual taxpayers and data for 2006  through 2008 from its Examination Operational Automation Database  (EOAD) and Audit Information Management System (AIMS) to  determine examination results about individual taxpayers’ compliance  with mortgage interest deduction rules; and    conducted a literature search of relevant tax publications and  interviewed non-government experts to enhance our understanding of  mortgage interest deduction compliance issues affecting taxpayers and  IRS.
To assess options to give IRS more information to enforce compliance  with mortgage interest deduction rules, we surveyed literature and  interviewed industry representatives about third-party information  reporting options that would give IRS useful information to improve its  ability to enforce mortgage interest deduction rules while minimizing  burden on third parties. We discussed the options, including their pros and  cons, with industry representatives from organizations such as the  Mortgage Bankers Association and the American Institute of Certified  Public Accountants and with others such as scholars who have expertise  in this area. We also met with IRS officials to obtain their views on the  feasibility of the options to improve compliance. Consideration of  statutory changes was beyond the scope of the request.
To determine if IRS could benefit from using private sector information to  detect noncompliance with home equity rules, we obtained statistical  information about home equity loans, home equity lines of credit, and  cash-out refinancings that have exceeded $100,000 from SMR Research,  one of several companies that compile and analyze mortgage data.  According to its Web site, SMR Research is the nation’s largest publisher  of industry and market research studies on the home mortgage business,  home equity lending, and other consumer loan subjects. We did not study  the information of any of the other company with extensive mortgage data  because our purpose was only to gather data on the type of information  that might be available from private sector sources that potentially could  benefit IRS in detecting home equity noncompliance. To assess the  reliability of the SMR Research data, we discussed the controls over the  database with a responsible company official and reviewed documentation  of the controls used to gather the data. We also used information from the  American Housing Survey for the United States: 2007, prepared by the  U.S. Department of Housing and Urban Development and the U.S. Census  Bureau, to confirm the reasonableness of SMR Research information. We  found the SMR database reliable for our purposes.
To find whether IRS’s guidance to taxpayers provided enough information  to properly calculate the mortgage interest deduction, we reviewed the  guidance to determine whether it mentioned the limitations prominently,  i.e., whether the limitations were mentioned directly as opposed to the  user being directed to another place.
To determine whether IRS’s examiners’ training and guidance provided  enough information on properly calculating the mortgage interest  deduction, we compared examiner training and guidance documents with  IRS publications and instructions on mortgage interest deductions, as well  as the applicable tax laws.
To describe how tax return preparation software programs and IRS’s Free  File program handle the mortgage interest deduction, we checked how the  three software packages used by 88 percent of individuals filing  electronically treated the debt limitations. We did this by logging on to the  software and reviewing the screens pertaining to the home mortgage  interest deduction. We also discussed our findings with company officials.  We reviewed tax year 2007 versions of each of the software packages and  included the versions used for IRS’s Free File program. Our results are  limited to the versions of the software packages we reviewed and cannot  be generalized to others. Free File offers free federal tax return  preparation and electronic filing services through these companies and  others. In addition, we reviewed documentation showing how software  widely used by paid tax return preparers for millions of taxpayers  throughout the country handles the mortgage interest deduction.
In addition, to respond to your request, we analyzed data from IRS’s  Statistics of Income (SOI) Division and the Compliance Data Warehouse  (CDW) to compile information about year-to-year changes in taxpayers’  mortgage interest deductions and Form 1098 filings for tax years 2004  through 2006.  Our analyses focused on the dollar amounts listed on  Schedule A, line 10; whether mortgage interest deductions on Schedule A,  line 10 matched Form 1098 amounts; frequency of paid preparer use by  those claiming a Schedule A, line 10 deduction; loan account numbers; and  amounts of mortgage interest deduction taken on forms other than  Schedule A to which we had access, including Schedule C for sole  proprietorship businesses, Schedule E for supplemental income and  losses, Schedule F for farms, and Form 4835 for farm rental income and  expenses.
Form 8829, Expenses for Business Use of Your Home, also can be used to report a  mortgage interest deduction, but mortgage interest reported on this form is not included in  the SOI database and consequently was not part of our analysis.
section_title: Appendix II: Schedule A, Itemized Deductions
section_title: Appendix III: Examination Results Involving Mortgage Interest Deductions
paragraphs: The following table compares examination results of IRS’s compliance  initiative projects (CIP) on the mortgage interest deduction with results  from its routine examinations (non-CIP).
section_title: Appendix IV: Examples Illustrating Mortgage Interest Deduction’s Complexity
paragraphs: As shown in the examples in this appendix, to determine the amounts of  mortgage interest that is deductible on Schedule A, a taxpayer or his or  her tax return preparer might need to follow many steps. First, the  taxpayer must find all his or her records pertaining to the property’s  acquisition and determine if the October 13, 1987, cutoff date applies, then  locate records of refinancing arrangements affecting acquisition debt, and  calculate the appropriate average annual balance. Second, the taxpayer  must determine home equity indebtedness, properly tracking, for instance,  the use of proceeds from home equity lines of credit, and determining  average balances and home equity amounts not deductible for AMT  purposes. Third, the taxpayer must know when loan proceeds finance  business use of the home, a partly rented home, or personal, business,  investment, or municipal bond expenditures because how the loan  proceeds are used determines the deductibility of the loan interest on the  tax return.
The American Institute of Certified Public Accountants gave us details of  the following scenario in which married homeowners refinanced their  house:  In 1990, a married couple borrowed $150,000 to buy a house.
By January 1, 2008, they had made principal payments of $50,000,  leaving an acquisition debt of $100,000.
On January 1, 2008, their house’s fair market value was $500,000, and  they refinanced their original loan for $400,000.
The new $400,000 mortgage would be allocated as follows:      The first $100,000 would be considered home acquisition debt, and  the interest on it would be deductible for the regular tax and for the  AMT.
The next $100,000 would be considered home equity debt, equal to  the home equity limitation and, therefore, deductible for the regular  tax but not for AMT unless it was used to acquire, construct, or  improve a main or second home.
The last $200,000 would be subject to “interest tracing” rules, with  deductibility depending on how the money was used—for instance,  if used for personal or municipal bond purposes, the interest would  not be deductible. However, if used for business or investment  purposes, the interest may be deductible.
The example would have been more complicated if not for the following  simplifying assumptions that we made:    The couple owned only one house and never borrowed money to  improve it.
They bought it after the October 13, 1987, the grandfather date when  rules changed regarding the amount of acquisition debt for which  interest is deductible.
This was the first time they refinanced the house.
The refinancing was done on the first day of the year and $1,000 in  principal was repaid each month, making monthly mortgage balances  easily calculated throughout the year.
They had no home equity loans other than a home equity part of the  refinancing and had not used a home equity line of credit, the use of  whose proceeds they would have had to have tracked.
They never used the house for business or rented any part of it.
We used the facts and assumptions of this example to complete the 13  steps in table 5, which is patterned after a worksheet in Publication 936.  Table 5 tracks the path taxpayers would follow in figuring their deductible  home mortgage interest.
A professional tax preparer also gave us the following example to  illustrate the complexity of the mortgage interest deduction. This example  may be atypical but reflects a more complicated case than the previous  example.
The client had more than one home, a mortgage greater than $1 million, a  refinancing, and home equity debt. In this case, the practitioner said that it  took over 4 hours of tracing transactions to calculate the acquisition and  home equity debt for one house, using an Excel spreadsheet to enter  amounts from closing statements for each of multiple refinancings. Home  equity debt had to be tracked separately because interest on allowable  home equity debt is generally not deductible for AMT purposes unless the  proceeds are used to buy, build, or improve a home. Acquisition debt after  refinancing had to only include the acquisition debt part of the previous  loan and closing costs. A deductible interest spreadsheet had to consider  beginning and ending loan balances, how loan proceeds were originally  used, and total interest paid.
section_title: Appendix V: Descriptive Data on Home Mortgage Interest Deduction Claims and Form 1098 Filings
paragraphs: This appendix presents analyses of Statistics of Income (SOI) Division and  Compliance Data Warehouse (CDW) data focusing on Schedule A, line 10  deductions and Form 1098 filings. Tables 6 through 12 use a SOI-derived  panel of taxpayers from 2004 through 2006, combined with CDW data on  Form 1098 filings, and table 13 uses SOI data exclusively.
Table 6 shows that for returns reporting a Schedule A, line 10 deduction  for all three years of the study period, about half had mortgage interest  from one Form 1098. For example, in 2006, 42.6 percent of taxpayers  reporting a mortgage interest deduction had one Form 1098, totaling about  $126.5 billion in Schedule A, line 10 deductions. Table 6 also shows that  some taxpayers reported a mortgage interest deduction on Schedule A,  line 10. This might mean that the taxpayer improperly filled out line 10 on  Schedule A or that IRS had not received a corresponding Form 1098 for  that particular taxpayer. The number of Form 1098 filings does not reflect  the number of homes a taxpayer has because, for example, taxpayers  would receive multiple Form 1098 filings in a given year if they sold a  home or if their existing mortgage was sold in the secondary market. The  margins of error for the tables in this appendix appear in app. VI.
Table 7 breaks down the pattern of Schedule A, line 10, deduction  amounts compared with the number of Form 1098 filings. For example, in  2006, 75 percent of taxpayers with two Form 1098 filings had deduction  amounts of $14,325 or less.
Table 8 shows the results of comparing Schedule A, line 10, deduction  amounts on tax returns to amounts reported to IRS by third parties on  Form 1098. As the table shows, about 65 percent to 67 percent of the  comparisons resulted in a match in all 3 years. However, in some  situations, our analysis showed that taxpayers’ deductions also were  greater or less than the amounts on Forms 1098. Over the three-year  period, 8.2 percent to 11.1 percent of tax returns’ deductions exceeded the  Form 1098 amount. This can occur legitimately when, for example, a  property is co-owed and one of the owners claiming the deduction does  not receive a Form 1098. It can also occur because of taxpayer or Form  1098 filing errors. Deductions can be less than the Form 1098 amounts  when taxpayers’ debts have exceeded the deduction limits or by error.
Table 9 shows both the distribution of Schedule A, line 10 deduction  amounts and the distribution of the differences between Schedule A, line  10 and Form 1098 statements filed for taxpayers who reported a Schedule  A, line 10 deduction. For example, in 2006, the median (50th percentile)  difference between Form 1098 and Schedule A amounts for taxpayers  whose deduction exceeded the Form 1098 amount was $727.
Our analysis also examined the change in mortgage interest deduction  amounts from 2004 through 2006, for those taxpayers who reported a  deduction in all 3 years. Table 10 shows the amount of change from 2004  to 2005 and then from 2005 to 2006. For example, the median (50th  percentile) changes for tax returns that had increases from both 2004 to  2005 and 2005 to 2006 were $1,496 and $1,691, respectively.
Table 11 shows the comparison of the year-to-year change in the number  of Forms 1098 taxpayers received with the dollar amount of change on  Schedule A, line 10, for the corresponding years. Only those taxpayers  with tax returns filed in all 3 years of our study are included in this  analysis. For example, the table shows that 581,950 tax returns had a  declining number of Form 1098 filings from both 2004 to 2005 and 2005 to  2006 (“Down all years”). For those taxpayers, the dollar amount of their  deductions declined by $2,471 from 2004 to 2005 for those at the 50th  percentile and decreased by $1,834 from 2005 to 2006. An increase in  deduction dollar amounts can occur when Form 1098 filings decreased, for  example, as in the year after a taxpayer sells one of his two homes, and  purchases a new home that has a larger mortgage interest deduction  amount than the previous two homes combined.
Table 12 shows an analysis of Form 1098 by mortgage loan account  numbers. We performed this analysis to show more precisely how  frequently taxpayers deducted mortgage interest on the same loan from  year to year, assuming the same loan number in different years referred to  the same loan. For example, from 2004 and 2005, about 25 million  taxpayers had one matching account number on their Forms 1098. The  third chart shows taxpayers who had matching accounts throughout the 3- year period. For example, 574,173 taxpayers had 3 matching account  numbers on their Forms 1098 in 2004, 2005, and 2006. Taxpayers with zero  matching account numbers likely means that they deducted interest on  different loans in different years.
Table 13 shows the distribution of taxpayers’ mortgage interest deductions  on Schedule A and on other schedules. Non-Schedule A interest  deductions may relate to forms such as Schedule C for small business,  Schedule E for rental property, and Schedule F for farming.
section_title: Appendix VI: Margins of Error Tables for Estimates in Appendix V
paragraphs: The following tables provide the margins of error for the corresponding  statistics reported in the previous appendix. For example, table 14  corresponds with table 6 in app. V.
section_title: Appendix VII: SMR Research’s Data on Home Equity Debt and How IRS Might Use Similar Data for Enforcement
paragraphs: Table 22 describes the three types of home equity loans—lump sum home  equity loans, home equity lines of credit, and refinancings—that SMR  Research included in its calculations of home equity loan debt that  exceeded $100,000, the home equity debt limitation.
Although SMR Research data do not include Social Security numbers  useful in data matching, its data include (1) homeowner names and  addresses; (2) loan dollar amounts useful for determining if loan  limitations for deductible interest were exceeded; and (3) other  information useful in audit selection or other compliance activities. An  example of this other SMR Research information that might be useful for  compliance purposes is information showing that more than a third of the  cash-out refinancing dollar amounts and the home equity loan dollar  amounts not known to be associated with lines of credit were in just 14  counties. Pinpointing homeowners with the largest home equity loans or  who live in one of a few counties with taxpayers having large proportions  of the nation’s home equity loan dollar value might ease IRS’s burden in  matching large amounts of information to its own databases. However, we  recognize that matching databases using names and addresses is much  more difficult than using Social Security numbers and that its viability  would have to be tested. For instance, IRS could run a name and address  match for a particular geographic location and follow up with only those  taxpayers whose information matched without extensive effort. If the test  were to show a low return on investment or did not deserve a higher  priority than competing efforts, it could be abandoned.
IRS follow-up could be examinations, possibly targeted at geographic  areas or taxpayers with the largest potential overdeductions;  correspondence to taxpayers as described in an earlier section; or  outreach to the tax return preparation community. Outreach to preparers  could inform them that the home equity area is being scrutinized by IRS  and, if taxpayers’ returns had not properly considered the $100,000 or fair  market value limitations, amended returns might be warranted. Non- examination efforts might be preferable to resource-intensive  examinations because the amounts of possible extra tax per noncompliant  taxpayer might be relatively small. For example, if a taxpayer with an 8- percent interest rate on a $200,000 home equity loan deducted interest on  the entire loan, the overdeduction would be about $8,000, or about $2,000  in taxes for a taxpayer in the 25-percent bracket.
section_title: Appendix VIII: Comments from the Internal Revenue Service
section_title: Appendix IX: GAO Contact and Staff Acknowledgments
subsections: section_title: Acknowledgments
paragraphs: In addition to the contact named above, Charlie Daniel, Assistant Director;  Amy Bowser; Sara Daleski; Eric Gorman; Lawrence Korb; Karen O’Conor;  Anne Stevens; and John Zombro made key contributions to this report.