In the consolidated cases of Charles Sophy v. Commissioner and Bruce Voss v. Commissioner, 138 TC No. 8, the Tax Court concluded that the $1,000,000 and $100,000 debt limitation on the deduction of home mortgage interest applies on a per residence, and not per taxpayer, basis. However, on appeal a divided Ninth Circuit Court of Appeals appeals reversed the Tax Court’s decision (Docket Nos. 16421–09, 16443–09)

Original Tax Court Decision

Charles and Bruce jointly owned two residences they both occupied and on which mortgages existed. Each one claimed home mortgage interest deductions on the entire amounts paid on the mortgages. The mortgages in question totaled more than $1.1 million, but each taxpayer’s ½ of the debt was less than the limitation.

The Tax Court disagreed with the taxpayer’s view that the limitations in IRC §163(h)(3) applied on a per taxpayer basis, rather holding that if a property has multiple owners, the deductible interest is limited to $1.1 million of the overall debt, with each taxpayer then further limited to only being able to deduct his/her share of that reduced interest deduction.

Ninth Circuit Disagrees

On appeal two of three judges on the Ninth Circuit panel hearing the case disagreed with the Tax Court’s view in this area.

The majority opinion notes that the statute doesn’t explain how to handle this matter, noting:

Discerning an answer from § 163(h) requires considerable effort on our part because the statute is silent as to how the debt limits should apply in co-owner situations.

And, in a footnote to this sentence the panel notes that the regulations don’t help in this regard either:

The relevant Treasury regulation, 26 C.F.R. § 1.163-10T, is also silent in this regard. The regulation provides a method of calculating qualified residence interest when the home debt exceeds the applicable debt limits in the statute, see id. § 1.163-10T(e), but it says nothing about how qualified residence interest should be calculated when there are multiple co-owners, whether married or unmarried.

The panel notes the Tax Court came to the same conclusion and, like this panel, had to search for an answer:

The Tax Court rejected a per-taxpayer reading of the debt limit provisions because it discerned in § 163(h)(3) a general "focus" on the qualified residence, Sophy, 138 T.C. at 210, and a "conspicuous[ ] absen[ce]" of "any reference to an individual taxpayer," id. at 211. Because the debt limit provisions do not speak directly to the situation of unmarried co-owners, it was reasonable for the Tax Court to look beyond those provisions in an effort to understand how the provisions should be applied. Ultimately, however, these other provisions of the statute do not sway us.

Rather the Ninth Circuit majority concentrated on a parenthetical reference in the statute itself.

The statute is mostly silent about how to deal with co-ownership situations, but it is not entirely silent. Both debt limit provisions contain a parenthetical that speaks to one common situation of co-ownership: married individuals filing separate returns. See id. § 163(h)(3)(B)(ii), (C)(ii). The parentheticals provide half-sized debt limits “in the case of a married individual filing a separate return.” Congress's use of the phrase “in the case of” is important. It suggests, first, that the parentheticals contain an exception to the general debt limit set out in the main clause, not an illustration of how that general debt limit should be applied. At the same time, the phrase “in the case of” also suggests a certain parallelism between the parenthetical and the main clause of each provision: other than the debt limit amount, which differs, we can expect that in all respects the case of a married individual filing a separate return should be treated like any other case. It is thus appropriate to look to the parentheticals when interpreting the main clauses’ general debt limit provisions.

Thus, the panel found, rather than being illustrative, that language outlined a treatment that is different from the norm for a married couple filing a joint return. The panel noted that Congress had specifically called out a special treatment for joint ownership when it created the first time homebuyer credit of §36 following the real estate crises.

Thus the panel found:

As § 36 makes clear, Congress knows how to treat a group of unmarried taxpayers as a single taxpayer for purposes of a particular tax benefit or burden. Congress could have done so here, but tellingly it did not. Instead, Congress did what it has done many times before, using the same language it has used before: It eliminated what would otherwise be a significant discrepancy between separately filing and jointly filing married couples by expressly reducing the debt limits for spouses filing separately.

In sum, the married-person parentheticals’ language, purpose, and operation all strongly suggest that § 163(h)(3)’s debt limit provisions apply per taxpayer, not per residence. Absent some contrary indication in the statute, then, we shall read the debt limit provisions as applying on a per-taxpayer basis.

So the panel allowed each taxpayer the full deduction.

One important item to note about this view is that it does serve to create a marriage penalty for this item, something the Tax Court’s view did not create. The dissent actually points this out, noting that the majority became concerned with odd results for those who were not married, but ignored a similarly odd result for getting married (though, to be fair, the majority is correct that Congress has often done this).

The dissent argues that given the ambiguity the Court should respect the IRS’s interpretation, citing back to a 2009 Chief Counsel Advice on this issue. The majority dismisses that, noting that such documents are not generally binding and should only be respected to the extent the analysis is persuasive. There the majority notes that the CCA claims the statute is clear on this point, something that the majority points out is not the case.

But it also seems clear that since the majority did not actually hold the IRS view was unreasonable and noted the IRS has not issued regulations, actual IRS regulations taking this position very well could make the provision work the way the IRS suggested in this case.

What Practitioners Should Do

This case again raises the issue of a published Tax Court opinion that is overturned on appeal by a Circuit Court of Appeals—and, in this case, a divided Circuit Court of Appeals panel.

The Tax Court is bound by this decision under the Golsen rule only for cases that would be subject to appeal to the Ninth Circuit. Thus, in most of the country the original opinion would still represent a published opinion of the Tax Court that would presumably control any Tax Court decision until and unless the Tax Court itself reverses the original position.

Obviously a taxpayer who received an adverse decision could appeal the decision, but since the panel that reversed the Tax Court was itself divided in its view, it’s very possible other Circuits could decide to back the Tax Court’s view.

Thus, for now, advisers dealing with clients who would not have recourse to the Ninth Circuit Court of Appeals will need to caution unmarried clients with joint ownership that the IRS would likely argue the limits apply per resident and the Tax Court is not likely to disagree with the IRS. But, as well, taxpayers who applied a per residence limit may very well wish to file claims for refund on those prior years to protect the taxpayers’ rights to refunds of overpaid tax.