BRUCE H. VOSS, Petitioner-Appellant,
COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee. CHARLES J. SOPHY, Petitioner-Appellant,
COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee
Argued and Submitted, Pasadena, California: February
Appeal from a Decision of the United States Tax Court. Tax Ct. No. 16443-09, Tax Ct. No. 16421-09.
The panel reversed a Tax Court decision involving the debt limit provisions for unmarried co-owners seeking to deduct mortgage interest for their qualified residence.
The panel held that the debt limit provisions of 26 U.S.C. § 163(h)(3) apply on a per-taxpayer basis to unmarried co-owners of a qualified residence. The panel remanded for determination of the proper amount of interest that taxpayers are entitled to deduct.
Dissenting, Judge Ikuta would defer to the Internal Revenue Service's reasonable interpretation of an ambiguous statute, which interpretation would limit unmarried taxpayers in this situation to deducting the same amount as married taxpayers filing jointly.
Emily J. Kingston (argued), Sideman & Bancroft LLP, San Francisco, California; Aubrey Hone, Hone Maxwell LLP, San Francisco, California, for Petitioners-Appellants.
Kathryn Keneally, Assistant Attorney General; Jonathan S. Cohen, John Schumann (argued), Attorneys, United States Department of Justice, Tax Division, Washington, D.C., for Respondent-Appellee.
Shannon P. Minter, Christopher F. Stoll, National Center for Lesbian Rights, San Francisco, California, for Amici Curiae Professors of Law.
Before: Michael J. Melloy,[*] Jay S. Bybee,
and Sandra S. Ikuta, Circuit Judges.
BYBEE, Circuit Judge:
This is a tax dispute brought by two unmarried co-owners of real property, Bruce Voss and Charles Sophy. For the 2006 and 2007 tax years, Voss and Sophy each claimed a home mortgage interest deduction under § 163(h)(3) of the Internal Revenue Code, which allows taxpayers to deduct interest on up to $1 million of home acquisition debt and $100,000 of home equity debt. After an audit, the IRS determined that Voss and Sophy were jointly subject to § 163(h)(3)'s $1 million and $100,000 debt limits and thus disallowed a substantial portion of their claimed deductions. Voss and Sophy challenged the IRS's assessment in Tax Court, arguing that the statute's debt limits apply per taxpayer such that they were entitled to deduct interest on up to $1.1 million of home debt each. The Tax Court agreed with the IRS.
We are now called upon to decide how § 163(h)(3)'s debt limit provisions apply when two or more unmarried co-owners of a residence claim the home mortgage interest deduction. Although the statute is silent as to unmarried co-owners, we infer from the statute's treatment of married individuals filing separate returns that § 163(h)(3)'s debt limits apply to unmarried co-owners on a per-taxpayer basis. We accordingly reverse the decision of the Tax Court and remand for a recalculation of petitioners' tax liability.
Section 163 of the Internal Revenue Code governs the deductibility of interest on a taxpayer's indebtedness. This section of the Tax Code, like much of the Code, is complex--it requires attention to definitions within definitions and exceptions upon exceptions. To assist the reader, we begin with a brief overview of the section's relevant provisions.
Section 163 begins with the general rule that interest on indebtedness is deductible. See 26 U.S.C. § 163(a). Subsection (h), however, provides that, " [i]n the case of a taxpayer other than a corporation," personal interest is not deductible. See id. § 163(h)(1) (" In the case of a taxpayer other than a corporation, no deduction shall be allowed under this chapter for personal interest paid or accrued during the taxable year." ). Nevertheless, " personal interest" is defined rather technically as " any interest allowable as a deduction . . . other than" certain specified categories of interest. See id. § 163(h)(2). One of those carved-out categories is " any qualified residence interest (within the meaning of paragraph (3))." Id. § 163(h)(2)(D).
Section 163(h)(3) thus provides that interest on a " qualified residence" is not " personal interest" and, accordingly, may be deducted by taxpayers who are not corporations. The Code defines " qualified residence" as the taxpayer's principal residence and " 1 other residence of the taxpayer which is selected by the taxpayer for purposes of this subsection for the taxable year and which is used by the taxpayer as a residence." Id. § 163(h)(4)(A)(i).
" Qualified residence interest" encompasses interest payments on two types of debt: acquisition indebtedness and home equity indebtedness. Id. § 163(h)(3)(A). " Acquisition indebtedness" generally means debt incurred in, or that results from the refinancing of debt incurred in, " acquiring, constructing, or substantially improving" a qualified residence. Id. § 163(h)(3)(B)(i). " Home equity indebtedness" generally means indebtedness, other than acquisition indebtedness, that is secured by a qualified residence and that does not exceed the difference between the amount of acquisition indebtedness and the home's fair market value. Id. § 163(h)(3)(C)(i). A home equity line of credit is a typical example of home equity indebtedness. So, for example, if a taxpayer has a purchase money mortgage (or the refinancing of such a mortgage) on both a primary home and a summer home, she can deduct interest payments on both mortgages. She may also deduct the interest on any home equity line of credit on both residences.
Significantly, the statute does not allow taxpayers to deduct interest payments on an unlimited amount of acquisition and home equity indebtedness. Instead, the statute limits " [t]he aggregate amount treated as acquisition indebtedness for any period" to $1,000,000 and " [t]he aggregate amount treated as home equity indebtedness for any period" to $100,000. Id. § 163(h)(3)(B)(ii), (C)(ii). " [I]n the case of a married individual filing a separate return," however, the statute reduces the debt limits to $500,000 and $50,000. Id. We shall refer to these provisions as the debt limit provisions.
If a taxpayer's total mortgage debt exceeds the debt limits, a Treasury regulation, 26 C.F.R. § 1.163-10T, provides the method for calculating qualified residence interest. Subsection (e) of that regulation sets out the usual method: qualified residence interest is calculated by multiplying the total interest paid by the ratio of the applicable debt limit over the total debt. See id. § 1.163-10T(e). For example, if a single individual has a $2 million mortgage and a $200,000 home equity line of credit, the ratio is 50%: $1.1 million (the total applicable debt limit under the statute) over $2.2 million (the total debt). Thus, the taxpayer is entitled to deduct 50% of whatever interest is paid or accrued during her taxable year.
In sum, under § 163 and the applicable Treasury regulation, a taxpayer may deduct the interest paid on a mortgage or home equity line of credit for a principal residence and a second home. For taxpayers other than married individuals filing a separate return, the deduction is limited to interest paid on $1 million of mortgage debt and $100,000 of home equity debt. If the taxpayer's home indebtedness exceeds $1.1 million, then she is entitled to deduct a portion of her interest, determined by the ratio of the statutory debt limit divided by her total actual debt. If the taxpayer is married filing a separate return, the debt limit is $550,000.
Although the statute is specific with respect to a married taxpayer filing a separate return, the Code does not specify whether, in the case of residence co-owners who are not married, the debt limits apply per residence or per taxpayer. That is, is the $1.1 million debt limit the limit on the qualified residence, irrespective of the number of owners, or is it the limit on the debt that can be claimed by any individual taxpayer? That gap in the Code is the source of the present controversy.
Bruce Voss and Charles Sophy are domestic partners registered with the State of California. They co-own two homes as joint tenants--one in Rancho Mirage, California and the other, their primary residence, in Beverly Hills, California.
When Voss and Sophy purchased the Rancho Mirage home in 2000, they took out a $486,300 mortgage, secured by the property. Two years later, they refinanced that mortgage and obtained a new mortgage, also secured by the property, in the amount of $500,000. Voss and Sophy are jointly and severally liable for the refinanced Rancho Mirage mortgage.
Voss and Sophy purchased the Beverly Hills home in 2002. They financed the purchase of the Beverly Hills home with a $2,240,000 mortgage, secured by the Beverly Hills property. About a year later, they refinanced the mortgage by obtaining a new loan in the amount of $2,000,000. Voss and Sophy are jointly and severally liable for the refinanced Beverly Hills mortgage, which, like the original mortgage, is secured by the Beverly Hills property. At the same time as they refinanced the Beverly Hills mortgage, Voss and Sophy also obtained a home equity line of credit of $300,000 for the Beverly Hills home. Voss and Sophy are jointly and severally liable for the home equity line of credit as well.
The total average balance of the two mortgages and the line of credit in 2006 and 2007 (the two taxable years at issue) was about $2.7 million--$2,703,568.05 in 2006 and $2,669,135.57 in 2007. Thus, whether § 163(h)(3)'s debt limit provisions are interpreted as applying per taxpayer (such that Voss and Sophy can deduct interest on up to $2.2 million of debt) or per residence (such that Voss and Sophy can deduct interest on up to $1.1 million of debt), it is in either event clear that Voss and Sophy's debt exceeds the statutory debt limits.
Voss and Sophy each filed separate federal income tax returns for taxable years 2006 and 2007. In their respective returns, Voss and Sophy each claimed home mortgage interest deductions for interest paid on the two mortgages and the home equity line of credit. The parties agree on the amounts of interest Voss and Sophy each paid for those years: Voss paid $85,962.30 in 2006 and $76,635.08 in 2007, and Sophy paid $94,698.33 in 2006 and $99,901.35 in 2007. The total interest paid was $180,660.63 in 2006 and $176,536.43 in 2007.
On their respective 2006 returns, Voss and Sophy each claimed a home mortgage interest deduction of $95,396, for a total of $190,792. Voss and Sophy now agree that this was at least $10,131.37 too much because Voss and Sophy together only paid $180,660.63 in interest that year. The additional amount represents interest that Voss paid on December 31, 2005, and was thus not deductible by either Voss or Sophy for taxable year 2006. For taxable year 2007, Voss and Sophy claimed less mortgage interest than they actually paid--Voss claimed a deduction of $88,268, and Sophy claimed a deduction of $65,614.
The IRS audited the 2006 and 2007 returns and, in 2009, assessed notices of deficiency to Voss and Sophy. The IRS calculated each petitioner's mortgage interest deduction by applying a limitation ratio to the total amount of mortgage interest that each petitioner paid in each taxable year. The limitation ratio was the same for both Voss and Sophy: $1.1 million ($1 million of home acquisition debt plus $100,000 of home equity debt) over the entire average balance, for each taxable year, on the Beverly Hills mortgage, the Beverly Hills home equity line of credit, and the Rancho Mirage mortgage.
Using that method, the IRS concluded that Voss was allowed to deduct $34,975 in 2006 and $31,583 in 2007. The IRS thus disallowed $60,421 of Voss's claimed deduction in 2006 and $56,685 of his claimed deduction in 2007. The IRS also found Sophy's returns deficient. The IRS concluded that Sophy was allowed to deduct $38,530 in 2006 and $41,171 in 2007. The IRS thus disallowed $56,866 of Sophy's claimed deduction in 2006 and $24,443 of his claimed deduction in 2007.
Voss and Sophy each filed a petition with the Tax Court, and the two cases were consolidated for joint consideration. The Tax Court granted the parties' joint motion to submit the cases for decision without trial and on the basis of stipulated facts and exhibits, and directed the parties to submit proposed computations for entry of decision.
Based on the stipulated facts, exhibits, and proposed computations submitted by the parties, the Tax Court reached a decision and issued an opinion in the IRS's favor. The Tax Court framed the question presented as " whether the statutory limitations on the amount of acquisition and home equity indebtedness with respect to which interest is deductible under section 163(h)(3) are properly applied on a per-residence or per-taxpayer basis when residence co-owners are not married to each other." Sophy v. Comm'r, 138 T.C. 204, 209 (2012).
The Tax Court began its analysis by looking to the definitions of acquisition indebtedness and home equity indebtedness in § 163(h)(3)(B)(i) and (C)(i). Id. at 210. The Tax Court noted that the term " any indebtedness" in both definitions is not qualified by language relating to an individual taxpayer (as in " any indebtedness of the taxpayer " ). Id. The Tax Court also pointed out that the phrase " of the taxpayer" in the definition of acquisition indebtedness " is used only in relation to the qualified residence [as in " qualified residence of the taxpayer " ], not the indebtedness." Id.
The Tax Court then examined the definition of qualified residence interest. Id. The Tax Court noted that the phrase " with respect to any qualified residence" in that definition appeared to be superfluous, as acquisition indebtedness and home equity indebtedness were already defined in relation to a qualified residence. Id. at 211. The Tax Court nevertheless found that the phrase was not superfluous because, in its view, " Congress used these repeated references to emphasize the point that qualified residence interest and the related indebtedness limitations are residence focused rather than taxpayer focused." Id. at 212.
The Tax Court further reasoned that the married-person parentheticals were consistent with its per-residence interpretation, as the parentheticals made clear that married couples--whether filing separately or jointly--are, as a couple, limited to deducting interest on $1 million of acquisition indebtedness and $100,000 of home equity indebtedness. Id. The purpose of the parentheticals, the Tax Court explained, was simply
to set out a specific allocation of the limitation amounts that must be used by married couples filing separate tax returns, thus implying that co-owners who are not married to one another may choose to allocate limitation amounts among themselves in some other manner, such as according to percentage of ownership.
Id. at 213.
Noting that nothing in the legislative history of § 163(h)(3) suggested any contrary intention, the Tax Court concluded that " the limitations in section 163(h)(3)(B)(ii) and (C)(ii) on the amounts that may be treated as acquisition and home equity indebtedness with respect to a ...