The IRS Office of Chief Counsel has issued a memorandum outlining how partial owners of a principal residence with a mortgage larger than $1 million should handle their mortgage deduction (CCA 200911007).
Under Sec. 163(h)(3), taxpayers can deduct interest paid on certain mortgages and home equity loans, but the Code limits the deduction to interest on the first $1 million of indebtedness on a mortgage used to purchase a home. (The limit on home equity indebtedness is $100,000.)
Where two taxpayers jointly own a principal residence with a mortgage larger than $1 million, the question has arisen as to how the $1 million limitation should apply. Should it apply to each taxpayer separately? Should married taxpayers filing jointly be treated as one taxpayer or two?
The Service explicitly rejects applying the $1 million to each taxpayer and says that the limit applies to the total combined amount of indebtedness on the home. The IRS looked at the language of the Code section, which refers to total "acquisition indebtedness" on the residence, not the amount owed by a particular taxpayer.
The memorandum supplies a formula for figuring each taxpayer's amount of qualified residence interest: multiply the amount of interest paid by the taxpayer by a fraction—$1 million divided by the amount of the mortgage.
This formula has the effect of dividing the limit between the taxpayers based on the portion of the interest they pay (which may or may not reflect their percentage of ownership). The memorandum does not explicitly address the case of married joint owners, but it does note that under Sec. 163(h)(3)(B)(ii) the limit is reduced to $500,000 for a married taxpayer filing a separate return.