Matter & Substance
  August 27, 2015

Mortgage Interest Itemized Deduction- Per-residence or Per-taxpayer Approach?

By: Guest Blogger Ian Hanke, Senior Tax Associate at Mowery & Schoenfeld

On August 11, 2015 the Ninth Circuit Court of Appeals reversed the tax court decision in the Voss case, now allowing two unmarried taxpayers who co-own a residence to each deduct mortgage and home equity debt interest up to the $1.1M indebtedness limit. This could be a landmark decision for unmarried individuals who co-own their residence.

The way the mortgage interest deduction works is this: you are allowed a deduction for interest paid on any home acquisition or qualifying home equity indebtedness, up to the $1.1M limit. This means that if you borrow more than $1.1M, you would not be allowed a deduction for the interest paid on the indebtedness in excess of the $1.1M limitation. The question the Voss case addressed relates to how this limitation is applied- should it apply on a per-residence basis ($1.1M limit per residence you own) or on a per-taxpayer basis ($1.1M per taxpayer, essentially allowing $2.2M on a 50/50 co-owned property)?

Bruce Voss and Charles Sophy (domestic partners under California law) co-owned two California residences. One residence had a $500,000 mortgage and the other residence had a $2,000,000 mortgage and a $300,000 qualifying home equity line of credit. On their 2006 and 2007 separately filed federal income tax returns, the taxpayers each claimed amounts of mortgage interest up to the $1.1M indebtedness limit.

Originally, the tax court decision ruled that the debt limit applies on a per-residence basis, an approach which would disallow a large percentage of the mortgage interest from being deducted. However, upon appeal of the tax court's decision, the Ninth Circuit Court of Appeals reversed this decision stating that the debt limit applies on a per-taxpayer basis. When applying the per-taxpayer basis rules, each unmarried taxpayer that co-owns a residence is considered responsible for half the interest on the residence. See the below example for the potential tax impact of this decision:

Assume total mortgage interest paid of $50,000 on a residence co-owned by two taxpayers.

Per-residence Basis:

1,100,000 limit / 2,800,000 total qualifying indebtedness = 39.29%

$50,000 * 39.29% = $19,645 total deduction, $9,822 per taxpayer

Per-taxpayer Basis:

$1,100,000 limit/1,400,000 total qualifying indebtedness = 78.57%

$50,000 * 78.57% = $39,285 total deduction, $19,643 per taxpayer

Difference in itemized deduction: $9,820 per taxpayer