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Unmarried Couples Keep A Tax Perk (For Now)

facade of a large house with a detached garage
photo courtesy Sherwood Real Estate

Sometimes the Internal Revenue Service has to admit that the tax law says what it says and that taxpayers are entitled to assume that it means what it says, even if tax enforcers believe the law’s authors did not mean to say what they actually said.

The IRS issued an Action on Decision notice last week indicating it will acquiesce to the decision by the 9th U.S. Circuit Court of Appeals in Voss vs. Commissioner. The case, which both I and my colleague ReKeithen Miller have previously discussed in this space, concerned an unmarried California couple who deducted interest on up to $1.1 million each of mortgage debt secured by property they jointly owned. The men, Charles Sophy and Bruce Voss, were domestic partners, but even had they been married, the Defense of Marriage Act would have required the IRS to consider the men single at the time they filed.

The law cuts the limits on deductible debt in half for married couples, even when they file separate returns. Sophy and Voss reasonably concluded, however, that this limit did not apply to them, since they were not married. The IRS disagreed.

In 2012, Tax Court Judge Mary Ann Cohen upheld the IRS’ position on the assumption that Congress meant to apply the limit per household, not per taxpayer. Last summer, the 9th Circuit rationally decided that whatever Congress meant, the wording of the existing statute was clear and that it supported the taxpayers’ position, not the IRS. The appeals court reversed Cohen’s ruling.

The IRS’ acquiescence means the Service has instructed its agents not to challenge taxpayers whose facts are similar to those of the case in question – in this instance, taxpayers who were not legally married at the time they shared ownership of a home, and who each claimed deductions for mortgage interest on debt that individually did not exceed the $1.1 million limit on principal balance but whose combined balance was greater than $1.1 million.

Today, unlike when Voss and Sophy filed in 2006 and 2007, same-sex couples do not have to worry about whether the IRS will recognize their marriages. But there are still many couples, both same-sex and opposite-sex, who cohabit but are not married. Some of these couples jointly own property, and some of them have large enough mortgages to find themselves in a position to take advantage the ability to use both individual deduction limits. The IRS, in the wake of the 9th Circuit’s ruling, has backed down from the position that they cannot do so.

The appeals court reached the right result, and realistically the IRS probably had little choice but to follow it. To do otherwise would have been to blur the distinction between the state of being married and being unmarried, ambiguity which – now that same-sex couples can be married everywhere in the U.S. – has neither legal nor practical basis. Had the IRS continued to force other taxpayers to go to court, it could have been liable for covering their legal expenses when they inevitably won.

All the same, I would advise unmarried couples to think carefully before deciding to take out a lot of home mortgage debt based solely on this outcome. With mortgage rates at historic lows, taking on even a large mortgage is not necessarily a bad idea at all – as long as you are not counting on future tax benefits to justify the transaction. The law as it stands is clear, but it is hardly set in stone.

On the contrary, Congress could easily change the tax code to conform to the IRS’ initial position, and it would not surprise me if it eventually does so. It is true, as the Court of Appeals observed, that this is not the only marriage penalty in the Internal Revenue Code. Yet I cannot think of a reason why lawmakers would want to allow unmarried couples, and especially those with the affluence to support more than $1.1 million in mortgage debt, to obtain a tax benefit that married couples don’t get.

I suspect that the original statute used marriage as a rough indicator of when two people are economically sharing a home, rather than subdividing it. The information necessary to determine whether a house is occupied by a cohabiting but unmarried couple, as opposed to roommates or multiple distinct family units, probably accounted for the wording of the original rule. I could easily see Congress deciding that such complexity is a reasonable price to pay or, more simply, settling on a “per residence” rule regardless of the relationship among taxpayers who live there.

Either way, I think sooner or later the law will change – possibly in conjunction with a boost in the general limit on deductible mortgage debt, which has not changed in 30 years. We cannot know until it happens, but for now, I would advise unmarried couples not to count on this particular wrinkle in the law lasting another 30 years.

Larry M. Elkin is the founder and president of Palisades Hudson, and is based out of Palisades Hudson’s Fort Lauderdale, Florida headquarters. He wrote several of the chapters in the firm’s recently updated book, Looking Ahead: Life, Family, Wealth and Business After 55. His contributions include Chapter 1, “Looking Ahead When Youth Is Behind Us,” and Chapter 4, “The Family Business.” Larry was also among the authors of the firm’s book The High Achiever’s Guide To Wealth.

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