IRS Says Interest Deduction Limitation on Acquisition Indebtedness Applies on a Per-Mortgage Basis

March 23, 2009 | Roger McEowen

The IRS Chief Counsel's Office has recently issued a legal memorandum in which it determined that the $1 million limitation on the deduction of mortgage interest on acquisition indebtedness under I.R.C. Sec. 163(h)(3)(B) applies on a per-mortgage basis, rather than on a per-taxpayer basis.  That means for multi-million dollar homes that are co-owned by unmarried persons, interest is deductible only on $1 million of acquisition indebtedness, not the interest attributable (at the maximum) to a single $2 million mortgage (attributed due to ownership equally between the spouses). 

Under the facts of the memorandum, the taxpayer owned a principal residence that was acquired with a mortgage in excess of $1 million.  The taxpayer paid all of the interest due on the mortgage for the first two years.  In year two, the taxpayer transferred the residence to himself and a co-owner.  In the third year, both the individual and the co-owner paid a percentage of the interest due on the mortgage.  In year three, the taxpayer argued that he could deduct the interest attributable to $1 million of indebtedness incurred in acquiring the residence and that the co-owner could also deduct interest on up to $1 million in additional acquisition indebtedness on the same residence.  IRS, however, was not amused by the argument and noted that the statute (I.R.C. Sec. 163(h)(3)(B)(ii)) clearly did not support the taxpayer's argument.  Instead, IRS said that the qualified residence interest deduction is limited to $1 million of total aggregate acquisition indebtedness.  ILM 200911007 (Nov. 24, 2008).

Note:  The exclusion of gain on sale of the principal residence (I.R.C. Sec. 121) applies on a per-taxpayer basis in a co-owner situation.