## Facts

- Charles J. Sophy and Bruce H. Voss were unrelated, unmarried co-owners of two California residences and were jointly and severally liable on the mortgages.
- They purchased a Rancho Mirage home in 2000 and refinanced it in 2002 with a $500,000 mortgage.
- They purchased a Beverly Hills home in 2002, refinanced it in 2003 with a $2,000,000 mortgage, and obtained a $300,000 home equity line of credit secured by that property.
- For 2006 and 2007, the Beverly Hills property was their principal residence and the Rancho Mirage property was their second residence.
- The combined average outstanding mortgage and HELOC debt in 2006 was about $2.7 million, with comparable levels in 2007.
- Each taxpayer separately claimed qualified residence interest deductions as though each was entitled to the full statutory debt caps under I.R.C. § 163(h)(3): $1,000,000 of acquisition indebtedness plus $100,000 of home equity indebtedness.
- The IRS disallowed portions of each taxpayer’s deductions, applying the § 163(h)(3) caps to the combined debt attributable to the residences rather than allowing each co-owner a separate set of caps.
- The cases were consolidated and submitted fully stipulated for decision in the Tax Court.

## Issues

1. Whether the I.R.C. § 163(h)(3) dollar caps on acquisition indebtedness and home equity indebtedness apply on a per-taxpayer basis or on a per-residence basis when multiple unmarried co-owners are jointly liable on the debt.
2. Whether the IRS properly reduced each petitioner’s qualified residence interest deductions by applying the caps to the combined indebtedness on the residences.

## Decision

- The Tax Court held that the § 163(h)(3) limitations apply on a per-residence basis, not a per-taxpayer basis.
- The court sustained the IRS’s method of limiting deductible interest by applying the caps to the combined acquisition and home equity indebtedness tied to the qualified residences.
- Decisions were entered for the Commissioner, upholding the deficiencies for 2006 and 2007.

## Legal Principles

- Under I.R.C. § 163(h), personal interest is generally nondeductible; “qualified residence interest” is deductible only to the extent it is paid on “acquisition indebtedness” or “home equity indebtedness” with respect to a qualified residence.
- The § 163(h)(3)(B)(ii) and § 163(h)(3)(C)(ii) dollar limitations operate as ceilings on the total indebtedness that may be treated as acquisition or home equity indebtedness with respect to a qualified residence for purposes of the interest deduction.
- The special reduced limits for married individuals filing separately do not convert the statutory caps into taxpayer-based limits; they function as an allocation rule within the same residence-based limitation framework.
- A reading that allows each co-owner to claim a full set of caps was rejected as inconsistent with the statute’s structure because it would permit multiple co-owners to multiply the aggregate deductible debt tied to a single residence.
- Where total debt exceeds the statutory ceilings, deductible qualified residence interest must be computed by limiting the underlying qualifying debt to the capped amounts.

## Conclusion

The Tax Court concluded that the mortgage-debt ceilings in I.R.C. § 163(h)(3) constrain the total qualifying debt associated with a qualified residence, so unmarried co-owners cannot each claim a separate $1,000,000/$100,000 limit for the same residences, and the IRS properly disallowed excess interest deductions.


Sophy v. Commissioner, 138 T.C. 204 (2012)