Mortgage interest: greater home mortgage interest deduction now allowed.

• Author: Josephs, Stuart R.
• Position: Fed Tax

The IRS has reversed its position as to whether debt, exceeding $1 million, incurred to acquire, construct or substantially improve a qualified residence constitutes "home equity debt" [Under IRC Sec. 163(h)(3)(C)].

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Legislative History

The present version of Sec. 163(h)(3) was enacted by the 1987 Revenue Act. The Ways and Means Committee Report, which the Conference Committee followed, states, "... the total amount of acquisition debt that can give rise to qualified residence interest is $1 million ... ."

Judicial History

In Pau v. Commissioner, TC Memo 1997-43, the Paus purchased a primary residence with a mortgage of $1,330,000. They claimed a home mortgage interest deduction, limited to interest on $1.1 million of debt.

The IRS issued a notice of deficiency disallowing this deduction. A revenue agent subsequently allowed the deduction, but limiting it to interest on $1 million of debt.

Judge Parr's opinion states that the parties disputed the amount of debt that should be used to compute the deduction.

This opinion concludes: "Sec. 163(h) restricts home mortgage interest deductions to interest paid on $1 million of acquisition indebtedness. ... Acquisition indebtedness is defined as that which is 'incurred in acquiring, constructing, or substantially improving any qualified residence of the taxpayer, and ... is secured by such residence" [Sec. 163(h)(3)(B)]. A taxpayer may be entitled to a greater deduction if he has incurred home equity indebtedness up to $ 100,000, as allowed by Sec. 163(h)(3)(G)(ii). There can be no additional deduction where taxpayers fail to show that they had home equity indebtedness. See Notice 88-74. ... Home equity indebtedness is defined as 'any indebtedness [(other than acquisition indebtedness) secured by a qualified residence' [Sec. 163(h)(3)(C)] (emphasis added).

"Petitioners ... did not demonstrate that any of their debt was not incurred in acquiring, constructing or substantially improving their residence and thus have failed to carry their burden of proof. We therefore sustain respondent's determination as to the amount petitioners may properly deduct for home mortgage interest."

Note: Notice 88-74 reads, in part: "Treatment of debt which is partially acquisition indebtedness and partially home equity indebtedness: Regulations will provide that a single debt may qualify as partially acquisition and partially home equity indebtedness.

"Therefore, for example, if a taxpayer incurs a...