IRS agrees that mortgage interest deduction limit applies on per-taxpayer basis.

• Author: Helderman, Paul S.

Unmarried taxpayers who co-own a home are each entitled to deduct mortgage interest on $1.1 million of acquisition and home-equity indebtedness after the 1RS acquiesced in the Ninth Circuit's decision in Voss, 796 F.3d 1051 (9th Cir. 2015). The Ninth Circuit, in reversing the Tax Court's decision in Sophy, 138 T.C. 204 (2012), concluded that the mortgage interest limitation is meant to apply on a "per-taxpayer" basis, rather than on a "per-residence" basis.

Background

In 2000, Charles J. Sophy and Bruce H. Voss purchased a house together in Rancho Mirage, Calif., and financed the purchase by obtaining a mortgage that was secured by the Rancho Mirage house. In 2002, Sophy and Voss purchased a house together in Beverly Hills, Calif., which they financed with a mortgage secured by the Beverly Hills house. They acquired both houses as joint tenants and held them as joint tenants during the years in issue. They used the Beverly Hills house as their principal residence and the Rancho Mirage house as their second residence.

In 2006, Sophy and Voss paid mortgage interest of $94,698 and $85,962, respectively, and in 2007 paid $99,901 and $76,635, respectively. The total average balances during 2006 and 2007 of the Beverly Hills mortgage and home-equity loan and the Rancho Mirage mortgage were $2,703,568 and $2,669,136, respectively. Sophy claimed deductions for qualified residence interest on his 2006 and 2007 federal income tax returns of $95,396 and $65,614, respectively. Voss claimed deductions of $95,396 and $88,268 on his 2006 and 2007 tax returns, respectively.

The 1RS audited their 2006 and 2007 individual income tax returns and disallowed portions of their deductions for mortgage interest asserting that their deductions exceeded the limits provided by the Internal Revenue Code.

IRS Wins in Tax Court

In denying a portion of Sophy's and Voss's mortgage interest deduction, the IRS's argument focused on its interpretation of the acquisition indebtedness limitation that is found in Sec. 163(h) (3). The general rule under Sec. 163(h) (1) is that no deduction is allowed for the payment of personal interest. However, Sec. 163(h)(2) provides an exception for "qualified residence interest," as defined in Sec. 163(h)(3).

Qualified residence interest is any interest that is paid or accrued during the tax year on "acquisition" or "home equity" indebtedness with respect to a qualified residence. Acquisition indebtedness is defined as any indebtedness that...