This is the first of what I hope to be a series of small posts about small annoyances in the Tax Cuts and Jobs Act. Thus the pun. So if you think these posts resemble an Andy Rooney whine or a Seinfeldian rant please remember that I’m just a simple tax professor from West Texas, and a proceduralist to boot.
My first pique is with the proposed mortgage interest reform. It completely ignores a great opportunity to fix a problem in the current statute. The problem is with how the debt limit applies. Current law uses the passive voice to limit the size of the loans that can generate the mortgage interest deduction. For example, the $1,000,000 limit for acquisition indebtedness is written like this: “The aggregate amount treated as acquisition indebtedness for any period shall not exceed $1,000,000 ($500,000 in the case of a married individual filing a separate return)” § 163(h)(3)(B)(ii). The language limiting home equity indebtedness is similar.
The problem with the passive voice is that you cannot tell whether the limit applies to each qualified residence or to each taxpayer. In Voss v. Commissioner, 796 F.3d 1051 (9th Cir. 2015), the 9th Circuit complained that “Discerning an answer ... requires considerable effort on our part because the statute is silent as to how the debt limits should apply in co-owner situations.” When Andy Rooney says it, it’s a whine, but when the 9th Circuit says it, it’s a problem.
The 9th Circuit decided to interpret the language as imposing a per-taxpayer limit. So the two unmarried taxpayers in that case could each deduct the interest on each taxpayer’s separate acquisition indebtedness up to the limit of $1 million. But it turns out that married taxpayers could not do so because of the parenthetical language that cut the limits in half “in the case of a married individual filing a separate return.” As the dissent in Voss pointed out, the 9th Circuit’s solution to the passive voice problem created a not insignificant marriage penalty problem. In an Action on Decision, the Service acquiesced in Voss and will follow it.
Now you may ask why the tax writers here should fix the passive voice when the current language is now “settled.” Because it’s a substantive problem, that’s why. The reform lowers the limit of qualifying debt to $500,000. Sure, that’s an easy sell here in West Texas where home prices are low. How low? My wife and I paid $265,000 in 2010 for our 3,000 sq.ft. 4 BR, 3 BR, 2 car garage home on a .25 acre lot in an upscale neighborhood 2 miles from my office. So no, you won’t find a lot of sympathy in this part of the country for the new $500,000 mortgage limit.
But my middle-class home would sell for over $1 million in many areas of the country (and not just the coasts) and for many taxpayers the deductibility of mortgage interest could mean the difference between affording home ownership and not. Thus this “reform” puts greater pressure on taxpayers to find creative ways to avoid the limit. The old limit was not so bad. But the new limit could push more middle-class taxpayers into avoiding marriage for tax reasons. How ironic that this “family friendly” tax reform effort contains a reform that actually increases a marriage penalty!
Congress should revise the limiting language to something like this: “The aggregate amount of indebtedness taken into account under subparagraph (A) for any qualified residence for any period shall not exceed $500,000....” (bolded language added). That should fix the problem. Does anyone see that the fix create any other problems?
My post assumes the continuation of the mortgage deduction as a deduction. So it still has the upside-down feature of any deduction: it favors those in higher tax brackets. If you are going to subsidize home ownership, I agree with those who believe the better policy is to extend that subsidy to all taxpayers whether or not they have enough expenditures to itemize. Why should the federal government help only high-end taxpayers achieve the American Dream of home ownership?
Make the sucker a credit.
But that's too deep for a pique. So I leave to other, better qualified, commentators to explain. My point here is that if you are going to the bother of reforming § 163(h), at least fix known problems with current law.