In an Action on Decision (AOD 2016-02), the IRS has announced it will follow the Ninth Circuit's opinion in Voss v. Commissioner, 796 F.3d 1051 (9th Cir. 2015), rev'g Sophy v. Commissioner, 138 T.C. 204 (2012), and will apply the Section 163(h)(2) and (3) debt limit on deductions for qualified residence interest on a per-taxpayer basis, meaning that each taxpayer obligated on a mortgage may deduct mortgage interest on indebtedness up to $1.1m on a qualified residence. (Tax Alerts provide details on the Voss (Tax Alert 2015-1579 {}) and Sophy (Tax Alert 2012-477 {}) decisions.)

Background

Deciding an issue of first impression, a divided Ninth Circuit reversed the Tax Court in Voss to hold that unmarried co-owners of a home may each claim a mortgage interest deduction for up to the $1.1m indebtedness limit established under Section 163(h)(3). Noting that Section 163(h)(3) says nothing about unmarried individuals, the appeals court applied the statute's treatment of married individuals filing separately to infer that the debt limit provisions "apply to unmarried co-owners on a per-taxpayer basis."

Acquiescence

In the AOD, the IRS notes that in reversing the Tax Court, the Ninth Circuit "based its conclusion largely on its interpretation of the language of the statute that expressly provides that married individuals filing separate returns are entitled to deduct interest on up to $500,000 of home equity indebtedness. By providing lower debt limits for married couples, and not for unmarried co-owners, Congress singled out married couples for specific treatment, implying that an unmarried co-owner filing a separate return is entitled to deduct interest on up to $1,000,000 of acquisition indebtedness and $100,000 of home equity indebtedness."

The IRS clarifies that it "will follow the Voss opinion and will apply the Section 163(h)(2) and (3) limitations on a per-taxpayer basis, allowing each taxpayer to deduct mortgage interest on indebtedness of up to $1 million and $100,000, respectively, on a qualified residence."

Implications

Given the holding in United States v. Windsor, 133 S. Ct. 2675 (2013), regarding same-sex marriage, the Service likely acquiesced because it viewed situations similar to Voss will be relatively rare.  However, the position would still be applicable to those who choose not to marry.

Taxpayers are generally limited to three years from initial filing deadline to amend their tax returns and claim a refund. For those taxpayers who were previously limited on their mortgage interest deduction because of the IRS per-residence interpretation, they may want to file timely amended tax returns at the federal and state level. Certain states have different statute of limitations for refunds.  And of course, there is no guarantee that states would follow the acquiescence.

At first blush, the acquiescence may appear to present a unique planning opportunity.  When a taxpayer has a mortgage balance greater than $1.1 million, it might seem logical to add a non-spouse (typically an adult child) as joint tenant to the ownership of the home and the mortgage to leverage the $1.1 million in loan value per-taxpayer.

This idea has several procedural hurdles.  First, the ownership of the principal residence must also be transferred (if it is not owned already). This may lead to a gift. At the same time, the "new" borrower may have assumed the debt of another which may result in a deemed-sale of the property. Second, when the loan is from a commercial lender, the lender must approve the transaction, which may be easier said than done.  Third, the "new" borrower must have the capacity to handle the new mortgage interest.  Thus, to the extent that they have their own mortgage debts, the value of this transfer will be significantly limited.  Fourth, the "new" borrower must actually pay their share of the mortgage.  To the extent that the borrower doesn't have sufficient liquidity to make mortgage payments, it may necessitate future gifts to the child to facilitate mortgage payments. However, in Lang v. Commissioner, T.C. Memo 2010-286, the Tax Court held that payments made by the parent for the child's expenses were done with donative intent. In effect, the economic substance of the transaction is the same as a cash gift followed by payment of the expenses allowing the deduction for the child even though paid by the parent.  Additionally, this strategy may not work in the case where the child is a minor and does not have the legal ability to co-own a home or be able to engage in a lending transaction. But despite all of these procedural hurdles, this strategy may work in certain situations. However, the viability may be few and far between. 

———————————————