Frank and Collette McNamara v. Comm., TCS 2023-22
This post is part of our series on recent important tax cases that may be of interest to accounting, tax, and finance professionals. For more like this, see our Federal Tax Update and California Federal Tax Update, which offer a comprehensive analysis of the year’s most pivotal tax developments.
Home Mortgage Interest Deduction Revised by Tax Court (Frank and Collette McNamara v. Comm., TCS 2023-22)
In 2019, Frank and Collette McNamara owned two homes, which they acquired after Oct. 1987 and before Dec. 16, 2017. The McNamaras owned the first home in Virginia for the entire year. They owned the second home in Massachusetts until May 10, 2019, when they sold it. On their 2019 Form 1040, the McNamaras claimed a total mortgage interest deduction of $39,226 for their two homes. The IRS disallowed $9,140 of the deduction, asserting that the McNamaras miscalculated the deduction for the Massachusetts home. Despite having sold the home in May 2019, they calculated the deduction using a 12-month period to determine the average mortgage balance, the determination of which was necessary for calculating their mortgage interest deduction on up to the $1 million dollar limit in place for mortgages acquired before Dec. 16, 2017.
Mortgage balance is calculated only for the months prior to sale. The McNamaras erred when they calculated the average mortgage balance for their Massachusetts home using the 12-month period instead of the 5-month period during which the home secured the outstanding balance on the mortgage. Calculating the average mortgage balance for the Massachusetts home using a five-month period caused their mortgage indebtedness for 2019 to exceed the $1 million limit such that a portion of the interest they paid is not deductible. Accordingly, the Tax Court agreed with the IRS calculation of the mortgage interest deduction.
Example. The average loan balance for the residence owned for the entire year was $700,000. The average loan balance for the residence owned for five months before sale was $400,000 (5 months of $400,000 each month). The combined balance of loan one and two EXCEEDS the $1 million limit. If the loan is treated as a twelve-month balance (5 months of $400,000 and 7 months of zero each month thereafter), the average loan balance is $166,666. The combined balance of loan one and two is BELOW the $1 million limit.