Charles and Bruce purchased two houses together, one in Rancho Mirage and the other in Beverly Hills, California. Not only were they co-owners of the houses, they were co-obligors on the mortgages and home equity debt related to the properties. For the years in question, the total mortgage and home equity balances were approximately $2.7 million.
Both Charles and Bruce claimed a mortgage interest deduction based on debt of $1.1 million. This is the maximum indebtedness on which the interest deduction is allowed, which is a rule thoroughly covered in tax preparation courses. The IRS disallowed a portion of this deduction for both taxpayers, asserting that the $1.1 million limit applies to the property; it is not doubled simply because there are two separately filing owners. The position of the IRS is consistent with a Chief Counsel Advice issued in 2009.
Clearly the IRS is correct in its interpretation of the home mortgage deduction limits when married taxpayers are involved. The statute very clearly specifies that: “The aggregate amount treated as acquisition indebtedness for any period shall not exceed $1,000,000 ($500,000 in the case of a married individual filing a separate return).” With respect to home equity indebtedness, the statute provides: “The aggregate amount treated as home equity indebtedness for any period shall not exceed $100,000 ($50,000 in the case of a separate return by a married individual).” These standards are clearly understood by all tax professionals, such as those with training from enrolled agent classes. The IRS’s contention was that these indebtedness limitations are properly applied on a per-residence basis, regardless whether co-owners are married to each other. Thus, co-owners should collectively be limited to a deduction for interest paid on a maximum of $1.1 million of acquisition and home equity indebtedness. This issue has important implications for understanding tax matters in online CPA review courses.
Charles and Bruce argued that Congress, in using this particular language in the indebtedness limitations, intended to create a special rule for married couples -- a "marriage penalty" -- that does not apply to co-owners who are not married to each other. The Tax Court didn’t buy it, and held that the total deductions are limited to the interest on $1.1 million, no matter how many owners there are, and no matter if they are married or not.
Background
The Tax Court’s decision is founded on statutory interpretation. The court observed that the acquisition indebtedness definition uses the phrase “any indebtedness which is incurred” in conjunction with “acquiring, constructing, or substantially improving any qualified residence of the taxpayer and is secured by such residence,” noting that the word “taxpayer” in this context is used only in relation to the qualified residence, not the indebtedness. Likewise, the court pointed out that the operative language in the definition of home equity indebtedness is “any indebtedness” that is secured by a qualified residence (other than acquisition indebtedness), and again, the definition is not qualified by language relating to an individual taxpayer. This ruling emphasizes the importance of words chosen for sample CPA test questions that prepare accountants for real world cases like that of Charles and Bruce.
Furthermore, the term “qualified residence interest” is defined as "any interest which is paid or accrued during the taxable year on acquisition indebtedness with respect to any qualified residence of the taxpayer, or home equity indebtedness with respect to any qualified residence of the taxpayer." The definition of "home equity indebtedness" also includes the phrase "reduced by the amount of acquisition indebtedness with respect to such residence" (referring to a qualified residence).
Thus, in the view of the court, the definitions of the terms "acquisition indebtedness" and "home equity indebtedness" establish that the indebtedness must be related to a qualified residence, and the repeated use of the phrases "with respect to a qualified residence" and "with respect to such residence" in the provisions discussed above focuses on the residence rather than the taxpayer.
Rather than setting out a marriage penalty, as advanced by Charles and Bruce, the parenthetical language in the statute simply appears to set out a specific allocation of the limitation amounts that must be used by married couples filing separate tax returns. In other words, married taxpayers are only entitled to 50% of the limits when filing separately, implying that a licensed tax preparer for co-owners who are not married to one another asks if they choose allocating the limitation amounts among themselves in some other manner, such as according to percentage of ownership.
Question:
Which of the following may be a characteristic of deductible mortgage interest?
a. The interest is related to an unsecured line of credit
b. The interest is related to a home equity loan, the proceeds of which were used by the taxpayer to pay for a vacation
c. The interest is related to a loan for the acquisition of property not used as a residence by the taxpayer
d. The limitation imposed on married couples filing separate returns constitutes a marriage penalty
Answer: b IRS Circular 230 Disclosure Pursuant to the requirements of the Internal Revenue Service Circular 230, we inform you that, to the extent any advice relating to a Federal tax issue is contained in this communication, including in any attachments, it was not written or intended to be used, and cannot be used, for the purpose of (a) avoiding any tax related penalties that may be imposed on you or any other person under the Internal Revenue Code, or (b) promoting, marketing or recommending to another person any transaction or matter addressed in this communication.
Source: http://fastforwardacademy.blogspot.com/2012/10/marriage-penalty-applied-to-unmarried.html
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