Mortgage Interest Deduction Applies on a Per-Taxpayer Basis

By Sally P. Schreiber, J.D.

Unmarried taxpayers who co-own a residence can each deduct interest payments on home-acquisition and home-equity debt up to the $1.1 million limit in Sec. 163(h)(3), the Ninth Circuit Court of Appeals held, reversing a Tax Court decision (Voss, No. 12-73257 (9th Cir. 8/7/15), rev'g Sophy, 138 T.C. 204 (2012)).

Bruce Voss and Charles Sophy, domestic partners under California law, co-own two California residences, one in Rancho Mirage purchased in 2000, with a $500,000 mortgage on it, and the second in Beverly Hills, which they purchased in 2002, with a $2 million mortgage and a $300,000 home-equity line of credit.

The taxpayers filed separate federal income tax returns for 2006 and 2007, claiming separate amounts of mortgage interest indebtedness up to the $1.1 million limit. (Sec. 163(h)(3) allows taxpayers to deduct interest on up to $1 million in home-acquisition debt and up to $100,000 of home-equity debt.)

The IRS disallowed a portion of the deductions for mortgage interest on each taxpayer's return, determining that the taxpayers were jointly, rather than separately, subject to the Sec. 163(h)(3) limit.

Voss and Sophy each filed a Tax Court petition, and the two cases were consolidated. The Tax Court upheld the IRS's deficiency, explaining that the $1.1 million limitation should be applied on a per-residence basis, not a per-taxpayer basis (see "Qualified Residence Interest Limits Apply on a Per Residence Basis," for a discussion of the earlier decision).

On appeal, the Ninth Circuit acknowledged that the statute is silent about how the debt limit applies when there are unmarried co-owners of property, but it rejected the Tax Court's analysis nonetheless. It noted that if Congress wanted the debt limits to apply on a per-residence basis, it could have included that language, as it did for the first-time homebuyer credit, which requires allocation of the $8,000 credit if the residence is purchased by unmarried taxpayers.

According to the court, nothing in the statute supports the Tax Court's per-residence reading, and a number of things suggest the opposite. First, the court found that language in the statute regarding married taxpayers who file separate returns supported the interpretation that Sec. 163(h) was to apply on a per-taxpayer basis. Second, the statute's occasional omission of the word "taxpayer" did not bother the court because its repeated references to a "taxable year" also implied that Congress was focusing on the individual taxpayer, not the residence, since residences do not have "taxable years," only taxpayers do. The court also questioned how co-owners with different tax years would calculate the allocated deduction.

The court found that another point in favor of a per-taxpayer limitation is the definition of qualified residence. As it is defined, two co-owners could have different qualified residences. For example, because qualified residence is defined as a taxpayer's principal residence plus a second home, two co-owners could have separate principal residences and then share a vacation home. Under the per-residence approach, this would lead to practical problems in determining each of the co-owners' deduction amounts. Under the per-taxpayer approach, these problems do not occur, which suggested to the court that this was the correct interpretation.

In a dissenting opinion, Judge Sandra Ikuta objected to the majority opinion, which she said allowed "unmarried taxpayers who buy an expensive residence together to deduct twice the amount of interest paid on the debt secured by their residence than spouses would be allowed to deduct" (slip. op. at 18). Agreeing that the statute was ambiguous, she would defer to the IRS's interpretation.

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