OUR THOUGHTS ON:

Can Mortgage Prepayment Penalties and Late Penalties be Deducted

Real Estate

By Kyle Hazen

When taxpayers see “penalty,” the general assumption is the expense is non-deductible.

Oftentimes, when borrowers pre pay all or even a portion of their mortgage balance, their lender contractually obligates them to pay a penalty. Rev. Rul. 57-198 provides that a mortgage prepayment penalty is currently deductible as interest expense in accordance with IRC Section 201(c)(1). In the case of mortgage prepayment penalties, the reasoning is that the prepayment penalty is merely the higher cost of short-term borrowing versus long-term borrowing, therefore making the payment deductible as interest.

Similarly, if a late payment penalty is, in effect, an increased rate of interest, rather than an arbitrary charge not measured by the passage of time, it may be deductible. This deductibility is determined based on the facts and circumstances of each case. Case history has made the determination based on the resemblance that the penalty calculation bears to the interest calculation, the correlation to the passage of time and related to market rates, the consistency of the late charge amount, and the correlation between the charge and the amount of time the payment is late.

In the end, penalty (as it may relate to a mortgage) may not always mean that it is nondeductible.

Please contact your SD representative if you have any questions regarding the deductibility of mortgage prepayment and late penalties.

© 2013 Schneider Downs. All rights-reserved. All content on this site is property of Schneider Downs unless otherwise noted and should not be used without written permission.

This advice is not intended or written to be used for, and it cannot be used for, the purpose of avoiding any federal tax penalties that may be imposed, or for promoting, marketing or recommending to another person, any tax related matter.

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Material discussed is meant for informational purposes only, and it is not to be construed as investment, tax, or legal advice. Please note that individual situations can vary. Therefore, this information should be relied upon when coordinated with individual professional advice.

© 2018 Schneider Downs. All rights-reserved. All content on this site is property of Schneider Downs unless otherwise noted and should not be used without written permission.

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