Mortgage debt limit applied per taxpayer

Reversing a Tax Court decision, the Ninth Circuit held that two unmarried taxpayers who were co-owners of two homes were each entitled to deduct interest on $1.1 million of qualified residence debt. The appeals court held that a proper reading of the language of Sec. 163(h) indicates that the debt limit should be calculated on a per-taxpayer basis rather than on the per-residence basis used by the Tax Court.

Facts: Bruce Voss and Charles Sophy, unmarried taxpayers, jointly owned two homes in California. Voss and Sophy were jointly and severally liable for a mortgage on each home and for a home-equity line of credit on one of the homes. In 2006 and 2007, the total average debt balances secured by the homes were $2,703,568 and $2,669,136, respectively. Each taxpayer deducted home mortgage interest on his 2006 and 2007 federal income tax returns; however, after an audit of those returns, the IRS disallowed more than half of the interest deducted on the returns for each year. The Service used the total debt secured by the residences to calculate the interest deduction, allowing 40.7% ($1,100,000 ÷ $2,703,568) of the interest paid by each taxpayer in 2006 and 41.2% ($1,100,000 ÷ $2,669,136) of the interest paid in 2007. The taxpayers petitioned the Tax Court for relief, arguing the calculation should be based on their individual shares of the total debt that would allow each to deduct 81.4% ($1,100,000 ÷ $1,351,784) of the interest paid in 2006 and 82.4% ($1,100,000 ÷ $1,334,568) of the interest paid in 2007. The Tax Court agreed with the IRS’s interpretation of Sec. 163(h) (Sophy, 138 T.C. 204 (2012)), prompting the taxpayers’ appeal of the decision to the Ninth Circuit.

Issues: Sec. 163(h)(2)(D) allows a deduction for qualified residence interest, defined as interest paid on acquisition indebtedness (debt to acquire, build, or substantially improve the taxpayer’s principal residence and one other residence) plus interest paid on a home-equity loan. The maximum amount of home-equity debt eligible for the interest deduction is $100,000 ($50,000 in the case of a married individual filing a separate return), while the amount of acquisition debt cannot exceed $1 million ($500,000 in the case of a married individual filing a separate return). The Code does not address how the debt limits apply to unmarried co-owners of the residence(s), but the IRS has taken the position (see Chief Counsel Advice 200911007) that the $1 million acquisition debt limit applies to the entire debt incurred to acquire a qualified residence (per-residence approach), not the debt incurred in acquiring the taxpayer’s portion of the residence (per-taxpayer approach). The Tax Court held in Sophy that the per-residence approach should be used to calculate the debt limits for acquisition debt and home-equity debt, while the taxpayers argued that the per-taxpayer approach is the proper interpretation of Sec. 163(h).

Holding: The appeals court, in a 2—1 decision, held that the home-acquisition and home-equity debt limits should be applied on a per-taxpayer basis, reasoning from the language, operation, and purpose of the provisions’ parenthetical language regarding married taxpayers who file separate returns. The parenthetical language halves the limitation amount for married taxpayers filing separate returns. According to the court, this language means the limit applies on a per-taxpayer basis because Congress used the wording “in the case of a married individual filing a separate return” when it could have said “in the case of any qualified residence of a married individual filing a separate return.” The court also stated the parentheticals operate in a per-taxpayer manner because if they operated under a per-residence approach, they would permit the use of only $550,000 of total debt for a married couple filing separate returns.

Also, according to the court, the purpose of the parentheticals is to ensure that married co-owners, even when filing separately, are treated as a single taxpayer. If Congress had wanted to also treat two or more unmarried taxpayers as a single taxpayer for this purpose, the court stated, Congress could have written a specific provision allocating the amount among the co-owners, as it did with the first-time homebuyer credit. Therefore, the court reasoned, the absence of such a provision implies a per-taxpayer approach.

• Voss, Nos. 12-73257 and 12-73261 (9th Cir. 8/7/15)

—By Charles J. Reichert, CPA, instructor of accounting, University of Minnesota—Duluth.