Taxing Lessons Case Summaries

Case — Mortgage Interest Deduction

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TL Case Summ

NOTE: This case was overturned on appeal to the ninth circuit. Read the updated decision here.

 

THE QUESTION

Does the limitation on the home mortgage interest deduction apply per taxpayer or per residence?

THE DISPUTE

Taxpayer Says: Unmarried joint co-owners of a primary residence are each allowed a deduction for interest paid on up to $1.1 million of acquisition and home equity indebtedness. The full mortgage interest deduction should be allowed on the return of each co-owner.

Internal Revenue Service Says: The indebtedness limitations are properly applied on a per-residence basis, regardless of the number of owners or whether co-owners are married to each other. The deduction should be limited on both returns.

THE LAW

From Internal Revenue Code Section 163(h)(3)(B): Section provides: (i) In general.–The term “acquisition indebtedness” means any indebtedness which– (I) is incurred in acquiring, constructing, or substantially improving any qualified residence of the taxpayer, and (II) is secured by such residence. Such term also includes any indebtedness secured by such residence resulting from the refinancing of indebtedness meeting the requirements of the preceding sentence (or this sentence); but only to the extent the amount of the indebtedness resulting from such refinancing does not exceed the amount of the refinanced indebtedness. (ii) $1,000,000 limitation.–The aggregate amount treated as acquisition indebtedness for any period shall not exceed $1,000,000 ($500,000 in the case of a married individual filing a separate return).

From Internal Revenue Code Section 163(h)(3)(C): Section provides: (i) In general.–The term “home equity indebtedness” means any indebtedness (other than acquisition indebtedness) secured by a qualified residence to the extent the aggregate amount of such indebtedness does not exceed– (I) the fair market value of such qualified residence, reduced by (II) the amount of acquisition indebtedness with respect to such residence. (ii) Limitation.–The aggregate amount treated as home equity indebtedness for any period shall not exceed $100,000 ($50,000 in the case of a separate return by a married individual).

THE CAUSE OF THE DISPUTE

When you itemize, you can deduct interest you pay on a mortgage secured by your main home and a second home. Deductible interest can include interest you pay on a second mortgage, a line of credit or a home equity loan for those residences. Your deduction is limited to the interest paid on a total of $1.1 million of qualifying debt ($550,000 when you’re married and file separate returns).

In this case, two unmarried taxpayers paid interest on two homes they owned jointly. The homes had a combined mortgage balance of approximately $2.6 million during the years in question (2006 and 2007). The taxpayers owned the homes as joint tenants. They occupied one as a principal residence and the other as a second residence, and were jointly and severally liable for the mortgage payments. The interest was qualified mortgage debt.

On their income tax returns for 2006 and 2007, each taxpayer deducted interest paid on $1.1 million of the outstanding principal balance of the loans. They argue that the $1.1 million limitation applies to each individual taxpayer. Since the total qualifying debt exceeded $2.2 million, each could take an interest deduction on principal loan balances up to the $1.1 million limitation.

The IRS says the allowable deduction is the interest paid on $1.1 million of qualified interest per residence(s). The taxpayers can split the deduction for interest paid on debt of up to $1.1 million, but each cannot apply the limitation separately to loans on the same residence(s).

WHAT WOULD YOU DECIDE?

Make your selection, then see “The Court’s Decision” below for a full explanation

For the or for the

THE COURT’S DECISION

Download (PDF, 25KB)

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HL Carpenter, an experienced investor and a CPA, specializes in reader friendly articles on taxes and investing for individuals and small businesses, and publishes two newsletters: Taxing Lessons and Top Drawer Ink. Visit TaxingLessons.com and HLCarpenter.com.

This information should not be considered legal, investment or tax advice. Taxing Lessons and Top Drawer Ink Corp. do not provide legal, investment or tax advice. Always consult your legal, investment and/or tax advisor regarding your personal situation.

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Sorry, wrong answer :(
Right answer!
For the IRS. The word “taxpayer” in the relevant code sections is used only in relation to the qualified residence, not the indebtedness, and the phrase “any indebtedness” is not qualified by any language relating to an individual taxpayer. The repeated use of the phrases “with respect to a qualified residence” and “with respect to such residence” in the provisions focuses on the residence rather than the taxpayer. The limitations in section 163(h)(3)(B)(ii) and (C)(ii) on the amounts that may be treated as acquisition and home equity indebtedness with respect to a qualified residence are properly applied on a per-residence basis.
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