The Ninth Circuit Court of Appeals recently reversed a Tax Court decision (Voss v. Commissioner) and concluded, contrary to the Internal Revenue Service’s (IRS) position, that the Internal Revenue Code (IRC) Section 163(h)(3) limitations ($1 million of acquisition debt and $100,000 of home equity debt) are applied on a per-individual basis, and not a per-residence basis. As a result, unmarried co-owners were collectively eligible for a deduction for interest paid on a maximum of $2.2 million, rather than $1.1 million, of acquisition and home equity debt.
As background, deductible home mortgage interest includes interest on home acquisition and home equity debt. Home acquisition debt is debt incurred to acquire, construct or substantially improve any qualified residence of the taxpayer that is secured by the residence. Home equity debt is debt (other than acquisition debt) that is secured by a taxpayer's qualified residence.
Pursuant to IRC Section 163(h)(3), the aggregate amount treated as acquisition debt cannot exceed $1 million for any period, or $500,000 in the case of a married individual filing separately. In addition, the total amount treated as home equity debt for any period cannot exceed $100,000 ($50,000 in the case of a married individual filing separately).
In the Ninth Circuit case, the taxpayers, who were not married to each other, bought two houses together. They acquired the houses as joint tenants and financed the purchases by obtaining a mortgage that was secured by each house. The taxpayers also obtained a home equity line of credit for one of the houses. The taxpayers were jointly and severally liable on the mortgage and home equity debt, and they used one of the houses as their principal residence and the other as their second residence.
On audit, the IRS determined that the taxpayers, as co-owners of the two residences, were together limited in deducting interest on $1 million of acquisition indebtedness and $100,000 of home equity indebtedness. The IRS contended that the $1 million of acquisition indebtedness and $100,000 of home equity indebtedness limits were properly applied on a per-residence basis, regardless of the number of residence owners and whether the co-owners were married to each other. That is, co-owners are collectively limited to a deduction for interest paid on a maximum of $1.1 million of acquisition and home equity indebtedness ($1 million + $100,000). The taxpayers disagreed and sued in Tax Court.
In 2012, the Tax Court ruled in favor of the IRS and found that the limitations on the amounts that may be treated as acquisition and home equity indebtedness for a qualified residence were properly applied on a per-residence basis, rather than per-individual basis.
On August 7, 2015, the Ninth Circuit Court of Appeals decision reversed the Tax Court, holding that the limits apply on a per-individual, not a per-residence, basis. The Court of Appeals decision provided that the taxpayers were collectively eligible for a deduction for interest paid on a maximum of $2.2 million, rather than $1.1 million, of acquisition and home equity debt.
Taxpayers should use caution and monitor this case when relying on the Ninth Circuit’s decision because it is inconsistent with the IRS’s position. It will be interesting to monitor the IRS’s reaction to the case and how it chooses to enforce the issue in the future.
You’ve heard our thoughts… We’d like to hear yours
The Schneider Downs Our Thoughts On blog exists to create a dialogue on issues that are important to organizations and individuals. While we enjoy sharing our ideas and insights, we’re especially interested in what you may have to say. If you have a question or a comment about this article – or any article from the Our Thoughts On blog – we hope you’ll share it with us. After all, a dialogue is an exchange of ideas, and we’d like to hear from you. Email us at [email protected].
Material discussed is meant for informational purposes only, and it is not to be construed as investment, tax, or legal advice. Please note that individual situations can vary. Therefore, this information should be relied upon when coordinated with individual professional advice.