Tax Court Says Limitation on Deductible Mortgage Interest Applies to Unmarried Co-Owners

The Tax Court held that unmarried co-owners were together subject to the $1.1 million limit on personal residence indebtedness under Sec. 163(h)(3) (Sophy, 138 T.C. No. 8 (2012)). The taxpayers had argued that, for unmarried taxpayers, each owner should be subject to a separate limit, even though married taxpayers are clearly subject to a joint limitation.

Sec. 163(h)(3) permits a deduction for interest paid on certain mortgages and home equity loans, but limits the deduction to interest on the first $1 million of indebtedness on a mortgage to purchase a home, plus $100,000 for home equity indebtedness. The statute makes it clear that married taxpayers are subject to the limit jointly; they can deduct the interest on a mortgage up to $1 million if they file jointly, or $500,000 if they file separately (and an additional $100,000/$50,000 for home equity loans). The IRS’s position has been that unmarried taxpayers are subject to the same limitation and that the amounts must be allocated between the owners (Chief Counsel Advice 200911007).

The Tax Court agreed with the IRS, noting that Sec. 163(h)(3)(A) defines qualified residence interest as “any interest paid or accrued during a tax year on acquisition indebtedness or home equity indebtedness with respect to the taxpayer’s qualified residence” (Sophy, slip op. at 8). In addition, acquisition indebtedness is defined as any indebtedness that is incurred in “acquiring, constructing, or substantially improving any qualified residence of the taxpayer” (Sec. 163(h)(3)(B)(i)(I)). (Similar language is used for home equity indebtedness.) This language suggested to the court that Congress was directing the limitation at the level of the residence, not at the level of the taxpayer.