For decades, lawmakers have complained about the“marriage penalty”, which refers to the areas within the Internal Revenue Code (IRC) that tend to favor unmarried couples who cohabitate over those who are married.
The marriage penalty just became a lot bigger with the IRS’s agreement to allow a full deduction on mortgage interest for unmarried individuals who are co-owners of real estate that exceeds statutory deduction limitations.
The controversy started when an unmarried California couple, Bruce Voss and Dr. Charles Sophy, tried to claim the full mortgage interest deduction for $2.7 million in mortgages on two properties they owned jointly for the tax years 2006 and 2007. One of the properties had a mortgage of over $2 million, which exceeded the $1.1 million per-property statutory limitation.
The IRS disallowed the full deduction, and in a 2012 decision, the tax court agreed. However, in August 2015, the Ninth Circuit Court of Appeals overturned the tax court ruling and sided with Mr.Voss and Mr. Sophy. On August 1 of this year, the IRS issued AOD 2016-2, which was essentially acquiescence to the decision of the Ninth Circuit and an agreement to allow the unmarried couple to keep their full deduction.
The Potential Impact of the Ninth Circuit Mortgage Interest Deduction Ruling
Up until now, the IRS has allowed individuals to deduct interest for up to $1.1 million in mortgages on real estate property. It had previously been understood that this was a “per property” limitation, regardless of how many co-owners the property has. Under this ruling, the deduction is now applied “per individual” rather than “per property”.
So for example, if one individual owns a house with a $2 million mortgage, he/she can only deduct the interest paid on up to $1.1 million (or just over half) of the mortgage. However, if there are two owners and they are not married to each other, each individual is allowed to take the deduction up to the $1.1 million limitation.
Now here is where the marriage penalty comes into play. If that same property with the same mortgage amount is owned by a married couple, regardless of whether they file jointly or separately, they are only allowed to deduct interest paid on up to $1.1 million of the mortgage. This could amount to a difference of tens of thousands per year in lost deductions, just for being married.
Will Congress allow this disparity in the tax code to continue? Probably not. Complaints from married couples will likely compel lawmakers to address this issue in the not too distant future. But until then, the current imbalance with the mortgage interest deduction might tend to encourage cohabitation for those who jointly own expensive real estate.
If you want to know more about the 2015 Ninth Circuit Court ruling and how it may impact your personal tax situation, speak with your local accounting firm. Your tax accountant can explain all your options and how to ensure your tax strategies put you in the best possible financial position.