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Just about all of us at one point or another have deducted mortgage interest as an itemized deduction allowed under IRS Code Section 163 on Schedule A of your Form 1040 tax return. IRS Publication 936 and IRS Regulations 1.163 allow a married couple or single individual to deduct interest paid on debt no greater than $1.1M or $550K each filing separately. That is until Charles Sophy and Bruce Voss two unmarried joint owners of a home decided to file a tax return claiming $1.1 Million each or $2.2 Million total. So if you are not married and jointly own a home stay with us here on TaxView with Chris Moss CPA Tax Attorney to find out how in 2015 it appears that you are now able to deduct interest paid on $2.2 Million and learn how to protect that deduction from an almost certain IRS Mortgage Interest Audit perhaps many years later.
In 2002 Charles Sophy and Bruce Voss purchased a house in Beverly Hills California as joint tenants financed by $2.2 Million in debt. They filed a federal income tax return in 2006 and 2007 with all interest on over $2M in debt deducted on Schedule A of their personal 1040 Tax return. The IRS commenced an IRS Mortgage Interest Audit and disallowed all interest on debt over $1.1M. Sophy and Bruce appealed to US Tax Court in Sophy v IRS US Tax Court (2012).
Sophy and Voss argued to the Court that Section 163 limitations were applied per taxpayer with respect to co-owners who are not married and therefore they should be allowed interest on debt up to $2.2M. The Government argued that whether married or unmarried you still live in one house and get to use only one $1.1M limitation. Judge Cohen therefore had to decide whether or not the statutory limitation of Section 163 was properly applied on a per-residence or per-taxpayer basis where residence co-owners were as in the case of Sophy and Voss not married.
The Court reviewed the legislative history of Section 163 and concluded that because married couples filing separate returns had to split the exemption in half, so should unmarried couples. Sophy and Voss countered that Congress intended to create a special rule for married couples, the marriage penalty if you will, which should not apply to unmarried couples. Congress was silent on unmarried couples and therefore the marriage penalty should not apply to them. The Court ultimately found for the Government concluding that that nothing in the legislative history of Section 163 suggests that Congress had any other intention than to view mortgage debt on a per-residence basis. Therefore the per-taxpayer basis used by Sophy and Voss was overruled by the Court with a win for the IRS.
Sophy and Voss then appealed to the US Court of Appeals for the 9th Circuit in Pasadena California filing on August 7, 2015, in Voss c. Commissioner 796 F.3d 1051 (9th Cir. 2015). An Amici Curiae brief was filed by Shannon Minter and Christopher Stoll of the National Center for Lesbian Rights and Sophy and Voss were represented by Sideman & Bancroft LLP of San Francisco and Hone Maxwell LLP of San Francisco. The Government was represented by Assistant Attorney Generals Keneally, Cohen and Schumann from the US Dept. of Justice Tax Division in Washington DC
Sophy and Voss continued to argue that the US Tax Court should be overruled because Section 163 debt limits apply to unmarried co-owners on a per-taxpayer basis. Circuit Judge Jay Bybee acknowledges that Section 163 is specific with respect to a married couple but notes the IRS Code does not specify whether in the case of residence co-owners who are not married the debt is limited per residence or per taxpayer. The gap in the Code is the source of the present controversy Judge Bybee opines.
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If Congress, the Court reasons, wanted to go further and ensure that two or more unmarried taxpayers were treated as a single taxpayer for purposes of Section 163, then Congress could have done that with specific language in the Code. The Court gave as an example Section 36 of the Code the First Time Homebuyer credit where unlike the mortgage debt interest limitation in Section 163, First Time Homebuyer credit Section 36 says “Married filing separately each can take $4000 of the total $8000 credit AND if two or more individuals who are not married purchase a principal residence, the amount of the credit can not exceed $8000”. The Court concluded that a per-taxpayer reading of the statute debt limit provisions is most consistent with Section 163 and Treasury regulation 1.163 as a whole. The Court therefore reversed Sophy v IRS US Tax Court (2012) and remanded back to the US Tax Court the job of determining in a manner consistent with the 9th Circuit Opinion the proper amount of qualified residence interest under Section 163. Voss Sophy win, IRS loses.
But there’s more: Circuit Judge Ikuta writes a blistering dissenting Opinion claiming that the majority opinion allows unmarried taxpayers who buy expensive residences to deduct twice the amount of interest than married spouses would be allowed to deduct. The Dissent shows how over the years the IRS has promulgated numerous regulations and rulings showing how exactly unmarried taxpayers who jointly own a home can apportion the interest on the $1.1 M debt limitation of Section 163. Voss and Sophy’ s approach should be rejected because due respect and deference should be given the US Treasury interpretation of the statute citing Christensen v Harris 529 US 576 (2000). The Dissent called the Majority “an absurd” marriage penalty with the better solution being to defer to the IRS reasonable interpretation of the statute. Therefore Judge Ikuta concluded in his Dissent that he would affirm the US Tax Court below.
What does all this mean to any of you purchasing a home with debt of over $1.1M? First, in my view, even if you don’t live in the 9th Circuit, if you are unmarried in 2015 and co-own a home together with a larger mortgage than $1.1M make sure you consult with a tax attorney before you file your 2015 income tax return. It sure looks at least for now until the other Circuits chime in that you will have a good chance of supporting an interest deduction on debt of up to $2.2 million. Second, have your tax attorney include in your tax return Voss c. Commissioner 796 F.3d 1051 (9th Cir. 2015) to support your position. Finally until Congress amends Section 163 and the other Circuits chime in, you should expect an IRS Mortgage Interest Audit within perhaps years after you file your tax return. With proper preparation and planning you will have an excellent chance to win an IRS Mortgage Interest Audit as did Voss and Sophy. Thank you for joining us on TaxView with Chris Moss CPA Tax Attorney.
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