Issue
Is the $1,100,000 limitation on mortgage debt for purposes of determining deductible interest expense applied on a per-taxpayer or a per-residence basis?
Related Tax Rules or Regulations
Internal Revenue Code Section 163(h)(3) allows a deduction for qualified residence interest on up to $1,000,000 of acquisition indebtedness and $100,000 of home equity indebtedness. Should your mortgage balance (or balances, since the mortgage interest deduction is permitted on up to two homes) exceed the statutory limitations, the mortgage interest deduction is limited to the amount applicable to only $1,100,000 worth of debt.
Case Study
Two individuals that are non-spouses equally buy a personal residence, owning the home as joint tenants. Assuming the total acquisition mortgage debt is $2,000,000 and the total home equity loan $200,000, making total debt $2,200,000, with each paying interest on only the respective $1,100,000 share of the debt.
Is each taxpayer entitled to a full mortgage deduction because each paid interest on only $1,100,000 of debt, the maximum allowable under Section 163, or is the mortgage deduction limited because the total debt on the house exceeds the $1,100,000 statutory limitation?
Facts
In a 2012 case, Sophy v. Commissioner, the Tax Court heard a tax dispute brought by two unmarried co-owners of real property, Bruce Voss and Charles Sophy. For the 2006 and 2007 tax years, Voss and Sophy each claimed a home mortgage interest deduction under § 163(h)(3) of the Internal Revenue Code, which allows taxpayers to deduct interest on up to $1 million of home acquisition debt and $100,000 of home equity debt. After an audit, the IRS determined that Voss and Sophy were jointly subject to § 163(h)(3)’s $1 million and $100,000 debt limits and thus disallowed a substantial portion of their claimed deductions. Voss and Sophy challenged the IRS’ assessment in Tax Court, arguing that the statute’s debt limits apply per taxpayer such that they were entitled to deduct interest on up to $1.1 million of home debt each. The Tax Court agreed with the IRS.
Decision:
In Voss, Sophy’s companion case, the court was called upon to decide how § 163(h)(3)’s debt limit provisions apply when two or more unmarried co-owners of a residence claim the home mortgage interest deduction. The court held “[a]lthough the statute is silent as to unmarried co-owners, we infer from the statute’s treatment of married individuals filing separate returns that § 163(h)(3)’s debt limits apply to unmarried co-owners on a per-taxpayer basis.”
What It Means
Important in the Ninth Circuit’s decision was the statute’s treatment of married taxpayers who file separate returns for purposes of deducting mortgage interest. Section 163(h)(3) provides that “in the case of” a married taxpayer who files a separate return, the $1,000,000 limit on qualified residence interest and $100,000 of home equity interest are reduced to $500,000 and $50,000 respectively, and that aside from that specific exception, married taxpayers filing separately should be treated identically to married taxpayers under Section 163.
The statute gives each separately filing spouse a separate debt limit of $550,000 so that, together, the two spouses are effectively entitled to a $1.1 million debt, the same amount allowed for single taxpayers. The court in Voss placed great emphasis on the use of the phrase “in the case of,” noting that it suggests an exception to the general limitations. The Ninth Circuit stated that the point of the language was to treat two married taxpayers who file separately the same as married taxpayers or a single taxpayer, which indicates that the limitations are to be applied on a per-taxpayer, rather than a per-residence basis.
Voss, considered with recent cases like Windsor and Obergfell, indicates a massive shift in the federal tax treatment of same-sex couples that are homeowners. From now on, unless and until the law changes again, same-sex couples, legally married under state law, will no longer be forced to file as unmarried taxpayers and face the consequences resulting from the initial Sophy decision. Cohabitation is not limited to same-sex couples, thus the Ninth Circuit’s decision to allow each taxpayer who co-owns a house to claim an interest deduction on the full $1,100,000 of debt, as long as they are not married filing separately, should make many taxpayers happy.
If you have any questions about the tax implications of the sale of your home or the deductibility of interest paid on mortgage thereon, call THE TAX EXPERTS AT THE Thorgood Law Firm www.thorgoodlaw.com. For a FREE consultation call 212-490-0704.
