Faina Bronstein and her father-in-law purchased a home in Brooklyn for $1,300,000 in 2007, with each buyer jointly and severally responsible for the $1,000,000 mortgage.
Throughout 2007, Bronstein and her husband used the home as their primary residence, with Bronstein paying the full interest expense on the $1,000,000 loan, amounting to $50,000 for the year.
Bronstein and her husband chose to file their 2007 tax returns separately. On her separate return, Bronstein claimed the full $50,000 interest deduction related to the Brooklyn home.
As a reminder, Code Section 163 provides an exception to the general rule that personal interest is not deductible by permitting a deduction for qualified residence interest.
In general, a qualified residence is defined as a taxpayer’s principal residence
and one other home that is used as a residence by the taxpayer.[i] Qualified residence interest means any interest paid or accrued during a tax year on acquisition indebtedness or home equity indebtedness with respect to the taxpayer’s qualified residence.
Section 163(h)(3)(B) defines the term “acquisition indebtedness” as any indebtedness which–
(I) is incurred in acquiring, constructing, or substantially improving any qualified residence of the taxpayer, and
(II) is secured by such residence.
The deduction is subject to a limitation: The aggregate amount treated as acquisition indebtedness for any period shall not exceed $1,000,000 ($500,000 in the case of a married individual filing a separate return).
Additionally, Section 163(h)(3)(C) defines “home equity indebtedness” as any indebtedness (other than acquisition indebtedness) secured by a qualified residence. The interest deduction on home equity debt is similarly limited: the aggregate amount treated as home equity indebtedness for any period shall not exceed $100,000 ($50,000 in the case of a separate return by a married individual).
The IRS, using a plain interpretation of the statute, disallowed half of Bronstein’s interest deduction, arguing that because Bronstein’s filing status was “married filing separately,” she was limited to deducting the interest paid on only $500,000 of acquisition debt and $50,000 of home equity debt.
In her defense, Bronstein looked to the intent of the statute, arguing that the purpose of cutting the limitations in half for married filing separately taxpayers was to accommodate situations where the husband and wife jointly paid mortgage interest, allowing each spouse to take interest deductions on half of the full limitation amounts. In a situation where one spouse pays all the interest expense — as Bornstein did in the immediate case — she argued that she should be entitled to deduct interest on the full debt amounts of $1,000,000 and $100,000.
The Tax Court disagreed:
We believe section 163(h)(3)(B)(ii) clearly states that a married individual filing a separate return is limited to a deduction for interest paid on $500,000 of home acquisition indebtedness. Similarly, we believe section 163(h)(3)(C)(ii) clearly states that a married individual filing a separate return is limited to a deduction for interest paid on $50,000 of home equity indebtedness. Petitioner has not offered any unequivocal evidence of legislative purpose which would allow us to override the plain language of section 163(h)(3)(B)(ii) and (C)(ii). As a result, we agree with respondent that petitioner is not entitled to a deduction for the interest paid on the entire $1 million of acquisition indebtedness incurred in purchasing the property. Rather, petitioner is entitled to deduct interest paid on only $550,000 of the mortgage indebtedness.
[i] I.R.C. § 163(h)(4)(A)(1)
