Court Affirms Mortgage Interest Deduction Limitation for Unmarried Couples

January 15th, 2013

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.      

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