The IRS has not provided guidance on calculating the interest received from borrowers who have become delinquent and are only making partial payments. In the absence of IRS guidance, we can only recommend what we believe is a reasonable approach to calculating interest received for purposes of Form 1098 filings. We recommend reviewing your loan agreements to determine how partial or late payments are applied to principal, interest, and other items (such as escrow accounts). To the extent that your loan agreements treat such payments as interest payments, we believe they should be reported as interest received on Form 1098.
Please note, however, that we were unable to confirm this approach with an IRS attorney, for the reasons explained below.
The Internal Revenue Code and corresponding rules simply state that a lender must report “the amount of [mortgage] interest (other than points) received for the calendar year.” But the Code and its corresponding regulations do not provide a roadmap for determining how much of partial payments should be characterized as “interest received,” rather than characterizing them as reductions of loan principal, funds allocatable to escrow accounts, or as serving other non-interest purposes.
We spoke to an IRS attorney about this issue, and the attorney confirmed that it has not been addressed in IRS law, regulations or guidance to date. In addition, the IRS will not provide informal guidance on this issue, for two reasons: (1) similar issues are the subject of ongoing class action lawsuits in California (in the lawsuits, borrowers are suing their banks for submitting incorrect 1098 forms with regard to capitalized interest for modified mortgage loans), and (2) the IRS currently is working through its Industry Issue Resolution process with the goal of eventually proposing rules that would clarify how to report interest on Form 1098 (and the IRS attorney could not provide a timeline on when these rules might be proposed).
The IRS attorney did note that Form 1098 reporting does not track the accounting rules for allocations of interest (which may require partial payments to be allocated to loan principal rather than to interest). We suggested that Form 1098 reporting should follow the method of allocating payments to interest and principal that is set forth in the loan agreement — but the IRS attorney’s response was that Form 1098 reporting does not necessarily follow the loan’s contract terms, either, and that we should await further guidance when the IRS proposes its rules in the future. The IRS attorney’s only advice was to pick a “reasonable” approach and retain records in case it later becomes necessary to reissue corrected forms. As noted above, we believe that to the extent that your loan agreements treat such partial payments as interest payments, we believe they should be reported as interest received on Form 1098.
If a borrower stops making payments altogether for a calendar year, the answer is simpler: no Form 1098 would be required. Lenders are not required to file a Form 1098 for borrowers who have paid less than $600 in mortgage interest over a calendar year.
For resources related to our guidance, please see:
- Internal Revenue Code, 26 USC 6050H (Requires a lender that “receives from any individual interest aggregating $600 or more for any calendar year on any mortgage,” to report “the amount of such interest (other than points) received for the calendar year,” among other items.)
- IRS Industry Issue Resolution Announcement (December 29, 2015) (“Two requests for guidance were received and will be worked together: The first submitted by the Mortgage Bankers Association on reporting requirements under IRC 6050H following a significant modification of a mortgage where the principal amount of the modified mortgage exceeds the principal amount of the pre-modified mortgage. The second submitted by the American Bankers Association on reporting required on a mortgage where accrued but unpaid interest is added to the principal.”)