Under the Internal Revenue Code, mortgage interest is deductible from income, provided that the outstanding mortgage balance is less than $1 million. Similarly, interest payable on a home equity line of credit that is used to finance home improvements is deductible as well, but only up to a loan balance of $100,000. An unmarried couple may at first glance assume that if they each buy half of a $2 million house, they can each fully deduct his or her half of the mortgage interest on his or her individual tax return. This would be true if the $1 million limitation is per taxpayer. A recent U.S. Tax Court case ruled otherwise.
In Sophy v. Commissioner of Internal Revenue, 138 T.C. No. 8, an unmarried couple purchased two houses in California, a vacation home and a principal residence, with outstanding principal mortgages that exceeded $2 million combined as well as a home equity line of credit with a principal balance exceeding $200,000. They each claimed interest deductions for interest attributable to $1 million mortgage balance and $100,000 home equity loan balance. The IRS sent both deficiency notices, asserting that the $1 million and $100,000 caps are “per residence,” not “per taxpayer”. The Sophy couple brought the issue to court, arguing that the limitations were intended to impose a “marriage penalty” on married couples. The Court dismissed the couple’s argument, pointing out that a married couple filing separately would likewise be limited to half of the $1 million and $100,000 caps each.