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Victory for Co-Owners of Mortgaged Residences

by John Karls
In the wake of a 2015 appeals court decision, the IRS has announced that it will abandon a position it had taken with respect to co-owners of a mortgaged personal residence who are not married to each other. This fact pattern can arise in a number of situations, including:
  • Through inheritance (for example, siblings who inherit a home)
  • After a divorce, when it is not unusual for the divorced parties to continue to co-own the residence, either to maintain the same housing arrangement for children or perhaps just until the residence can be sold
The general rule is that a taxpayer can deduct interest on up to $1.1 million of “qualified housing” interest. (A “qualified residence” is defined in Section 163(h) of the Tax Code and in Temporary Regulation 1.163-10T.) For a taxpayer using the Married Filing Separately filing status, the $1.1 million becomes $550,000.

Let’s look at an example: Morgan and Pat each own 50% of a residence in North Dallas. The mortgage on the residence is $1.5 million, and the home is a “qualified residence” for each of them. To keep things simple, let’s assume that neither of them owns another residence with mortgage debt.

The IRS argued that the $1.1 million-dollar limit should be applied at the property level, not at the taxpayer level. (The Code section itself does not say this.) Thus, the IRS concluded that Morgan and Pat were each limited to deducting the interest on only $550,000 of debt, rather than on a full share of the debt ($750,000 each).

The United States Tax Court, which is widely thought to have a pro-IRS mentality, agreed with the IRS interpretation of the statute in a case involving taxpayers named Voss. However, the Court of Appeals for the Ninth Circuit, which covers a number of western states, rode to the rescue and overruled the Tax Court ruling in the Voss case in August 2015.

The IRS has now announced that it will acquiesce in the Court of Appeals decision and will no longer argue for a limitation by property. If you have filed a tax return limiting your mortgage interest deduction as the IRS had previously directed, you can now file an amended return to claim the additional interest expense deduction.

June 16, 2017

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John Karls - Partner, Tax - Dallas TX | Armanino
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