It seems as if we’ve been seeing news items every day for the last few months about the “the most sweeping overhaul of the US tax system in more than 30 years” that was just passed by Congress in December. Unsurprisingly, this massive revision has resulted in a mad scramble, as the IRS, accountants, tax attorneys, and other tax professionals grapple with the multitude of practical changes wrought by the new law. Those of us who deal regularly with tax-related real estate matters now face the daunting task of advising our clients about these issues.
One of the most controversial changes—for those of us in California, at least—is the limitation of the home mortgage interest deduction to the first $750,000 of mortgage debt, pursuant to Section 163(h)(3) of the Internal Revenue Code, as amended by Section 11043(a) of the Tax Cuts and Jobs Act. Existing mortgages have been grandfathered: Taxpayers may continue to deduct home mortgage interest up to the first $1,000,000 of mortgage debt existing as of December 14, 2017, and may refinance those mortgages subject to that same limitation so long as the amount of the new loan does not exceed the amount of the mortgage that is being refinanced. Still, since the median home price in large cities such as San Jose and San Francisco exceeds the $1 million mark, significant numbers of Californians will face a substantial reduction in the amount of home mortgage interest they can deduct.
For practical and political reasons, lawmakers in Congress expended a great deal of effort to enact the tax reform bill by the end of 2017. A number of lawmakers involved in that process noted that many details of the new law were being left for later correction, explication or clarification. In my review of the text of the statute, it appears to me that at least one particular ambiguity in the prior code provision—the failure to specify whether the mortgage debt limitation is meant to apply on a per residence basis or a per taxpayer basis, resulting in another example of a “marriage penalty” under the code—remained in the final text, and it is unclear to me how that uncertainty might be addressed down the road.
I first noted this issue in my blog several years back, when the U.S. Tax Court ruled in favor of the IRS against an unmarried couple who owned a primary residence and secondary residence as joint tenants, subject to over $2 million in mortgage debt for which they were jointly and severally liable. The couple took the position that they each were entitled to claim a deduction for the interest paid on up to $1,000,000 of the mortgage debt on the two residences on their separate returns. The IRS contended, however, and the U.S. Tax Court concurred, that the couple was each limited to claiming the deduction applicable to married taxpayers filing separate returns for interest paid on up to $500,000 of mortgage debt.
When the Ninth Circuit reviewed that Tax Court decision on appeal and sided with the taxpayers against the IRS, the court noted that the Section 163(h)(3) of the Internal Revenue Code and the regulations promulgated thereunder were silent with regard to the limitation on mortgage debt for which unmarried co-owners could deduct the interest paid, despite calling out this limitation with respect to married taxpayers filing separately, and suggested that Congress could have clarified its intentions in this regard, but did not do so. The IRS subsequently acquiesced in this ruling, as I pointed out in my blog article addressing these issues; the result was, as I noted, another “marriage penalty” under the tax code on couples with substantial income and assets.
In examining the language of the new law, it is clear that Congress did not amend Section 163(h)(3) to specify whether unmarried co-owners were subject to the same limitations as married taxpayers filing separately. The next question will be whether the IRS will continue in its acquiescence in the result in the Ninth Circuit’s ruling as it promulgates new regulations under that Section. Given the hostility being shown by Congress with regard to the home mortgage interest deduction under tax reform, it is not a certainty that the IRS will persist in this acquiescence. Time will have to tell.