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Clever home interest deduction to get under limit

August 16, 2016

This article by Mark R. Ashton at Fox Rothschild LLP can come in handy for Canadian resident USC married to NRA, especially with Toronto and other Canadian area high real estate values.

 

In recent years much has been written about the "marriage penalty" when it comes to federal income tax. As a group known as the Tax Foundation states it "An unmarried couple with equal incomes that earn a combined $300,000 would have a total tax bill of $83,232.50 ($64,374.50 from the individual income tax and an additional $18,858.00 from the payroll tax).  If they were to get married, they would be hit by a marriage penalty of $3,806.50.  The penalty has declined in significance over recent years but it still exists.

 

A year ago the US Court of Appeals for the 9th Circuit (i.e., the west coast) decided Voss v. Commissioner.  Voss and his life partner Sophy owned a house together on which there was a jumbo mortgage exceeding $1,000,000.  Section 163(h)(3) of the Internal Revenue Code limits home mortgage interest deductions to those attributable to not more than $1,000,000 in mortgage debt if used for acquisition and $100,000 of home equity loans.  The purpose of this law was to capitate home mortgage deductions for the wealthy and, in the case of the home equity cap to discourage people borrowing against home equity to fund activities unrelated to savings.

 

Personal interest is generally nondeductible. The government allows interest on qualified residences to be deducted with qualified residences being up to two taxpayer's homes, each being used as a residence.  The statute also states that individuals filing separately are limited to $500,000 each and $50,000 in the case of a home equity loan.

 

Taxpayer Voss and his partner Charles Sophy who are registered domestic partners under California law. And, together they own two homes with mortgages for which they are jointly liable.  For the tax year involved, their mortgages and home equity debt were about $2.7 million and were recorded on their primary residence in Beverly Hills.  They filed income tax returns separately for the tax years involved and each claimed averaging about $90,000 per annum.  The IRS reviewed the returns and assessed tax premised on the conclusion that any interest associated with debt above $1.1 million ($1 million acquisition and 100,000 home equity) was not deductible.

 

Messrs. Voss and Sophy filed in Tax Court asserting that the $1,100,000 limitations were not calculated per "residence" but per tax taxpayer.  The Tax Court agreed with the IRS and upheld the limitation on interest to $1.1 million.  But in a decision premised upon the express language found in Section 163 (h)(3) the US Court of Appeals held that the limitation is per taxpayer.  The Court notes that this is probably not what the Congress intended but it is what the statute says and, as such, the clear language trumps legislative intent.

 

The decision was rendered on August 7, 2015 and undoubtedly, the IRS has hoped that the Congress would adopt a technical amendment to correct this. But, that amendment has not been adopted and on August 1, 2016 the IRS issued something called an AOD (Action of Decision: 2016-2) stating that it accedes to this approach to home interest deductibility until Congress adopts a statute saying otherwise.  So big mortgage deductions for couples not filing jointly are there to be had until Congress finds the time and energy to close the door.

 

Voss v. Commissioner    796 F3d 1051 (9th Cir. 2015)

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