§163 — Interest
322 citing cases
Statute Text — 26 U.S.C. §163
There shall be allowed as a deduction all interest paid or accrued within the taxable year on indebtedness.
If personal property or educational services are purchased under a contract—
which provides that payment of part or all of the purchase price is to be made in installments, and
in which carrying charges are separately stated but the interest charge cannot be ascertained,
then the payments made during the taxable year under the contract shall be treated for purposes of this section as if they included interest equal to 6 percent of the average unpaid balance under the contract during the taxable year. For purposes of the preceding sentence, the average unpaid balance is the sum of the unpaid balance outstanding on the first day of each month beginning during the taxable year, divided by 12. For purposes of this paragraph, the term “educational services” means any service (including lodging) which is purchased from an educational organization described in section 170(b)(1)(A)(ii) and which is provided for a student of such organization.
In the case of any contract to which paragraph (1) applies, the amount treated as interest for any taxable year shall not exceed the aggregate carrying charges which are properly attributable to such taxable year.
For purposes of this subtitle, any annual or periodic rental under a redeemable ground rent (excluding amounts in redemption thereof) shall be treated as interest on an indebtedness secured by a mortgage.
In the case of a taxpayer other than a corporation, the amount allowed as a deduction under this chapter for investment interest for any taxable year shall not exceed the net investment income of the taxpayer for the taxable year.
The amount not allowed as a deduction for any taxable year by reason of paragraph (1) shall be treated as investment interest paid or accrued by the taxpayer in the succeeding taxable year.
For purposes of this subsection—
The term “investment interest” means any interest allowable as a deduction under this chapter (determined without regard to paragraph (1)) which is paid or accrued on indebtedness properly allocable to property held for investment.
The term “investment interest” shall not include—
any qualified residence interest (as defined in subsection (h)(3)), or
any interest which is taken into account under section 469 in computing income or loss from a passive activity of the taxpayer.
For purposes of this paragraph, the term “interest” includes any amount allowable as a deduction in connection with personal property used in a short sale.
For purposes of this subsection—
The term “net investment income” means the excess of—
investment income, over
investment expenses.
The term “investment income” means the sum of—
gross income from property held for investment (other than any gain taken into account under clause (ii)(I)),
the excess (if any) of—
the net gain attributable to the disposition of property held for investment, over
the net capital gain determined by only taking into account gains and losses from dispositions of property held for investment, plus
so much of the net capital gain referred to in clause (ii)(II) (or, if lesser, the net gain referred to in clause (ii)(I)) as the taxpayer elects to take into account under this clause.
Such term shall include qualified dividend income (as defined in section 1(h)(11)(B)) only to the extent the taxpayer elects to treat such income as investment income for purposes of this subsection.
The term “investment expenses” means the deductions allowed under this chapter (other than for interest) which are directly connected with the production of investment income.
Investment income and investment expenses shall not include any income or expenses taken into account under section 469 in computing income or loss from a passive activity.
For purposes of this subsection—
The term “property held for investment” shall include—
any property which produces income of a type described in section 469(e)(1), and
any interest held by a taxpayer in an activity involving the conduct of a trade or business—
which is not a passive activity, and
with respect to which the taxpayer does not materially participate.
In the case of property described in subparagraph (A)(i), expenses shall be allocated to such property in the same manner as under section 469.
For purposes of this paragraph, the terms “activity”, “passive activity”, and “materially participate” have the meanings given such terms by section 469.
The portion of the original issue discount with respect to any debt instrument which is allowable as a deduction to the issuer for any taxable year shall be equal to the aggregate daily portions of the original issue discount for days during such taxable year.
For purposes of this subsection—
The term “debt instrument” has the meaning given such term by section 1275(a)(1).
The daily portion of the original issue discount for any day shall be determined under section 1272(a) (without regard to paragraph (7) thereof and without regard to section 1273(a)(3)).
In the case of an obligor of a short-term obligation (as defined in section 1283(a)(1)(A)) who uses the cash receipts and disbursements method of accounting, the original issue discount (and any other interest payable) on such obligation shall be deductible only when paid.
If any debt instrument having original issue discount is held by a related foreign person, any portion of such original issue discount shall not be allowable as a deduction to the issuer until paid. The preceding sentence shall not apply to the extent that the original issue discount is effectively connected with the conduct by such foreign related person of a trade or business within the United States unless such original issue discount is exempt from taxation (or is subject to a reduced rate of tax) pursuant to a treaty obligation of the United States.
In the case of any debt instrument having original issue discount which is held by a related foreign person which is a controlled foreign corporation (as defined in section 957) or a passive foreign investment company (as defined in section 1297), a deduction shall be allowable to the issuer with respect to such original issue discount for any taxable year before the taxable year in which paid only to the extent such original issue discount is includible (determined without regard to properly allocable deductions and qualified deficits under section 952(c)(1)(B)) during such prior taxable year in the gross income of a United States person who owns (within the meaning of section 958(a)) stock in such corporation.
The Secretary may by regulation exempt transactions from the application of clause (i), including any transaction which is entered into by a payor in the ordinary course of a trade or business in which the payor is predominantly engaged.
For purposes of subparagraph (A), the term “related foreign person” means any person—
who is not a United States person, and
who is related (within the meaning of section 267(b)) to the issuer.
This subsection shall not apply to any debt instrument described in section 1272(a)(2)(D) (relating to loans between natural persons).
In the case of an applicable high yield discount obligation issued by a corporation—
no deduction shall be allowed under this chapter for the disqualified portion of the original issue discount on such obligation, and
the remainder of such original issue discount shall not be allowable as a deduction until paid.
For purposes of this paragraph, rules similar to the rules of subsection (i)(3)(B) shall apply in determining the amount of the original issue discount and when the original issue discount is paid.
Solely for purposes of sections 243, 245, 246, and 246A, the dividend equivalent portion of any amount includible in gross income of a corporation under section 1272(a) in respect of an applicable high yield discount obligation shall be treated as a dividend received by such corporation from the corporation issuing such obligation.
For purposes of clause (i), the dividend equivalent portion of any amount includible in gross income under section 1272(a) in respect of an applicable high yield discount obligation is the portion of the amount so includible—
which is attributable to the disqualified portion of the original issue discount on such obligation, and
which would have been treated as a dividend if it had been a distribution made by the issuing corporation with respect to stock in such corporation.
For purposes of this paragraph, the disqualified portion of the original issue discount on any applicable high yield discount obligation is the lesser of—
the amount of such original issue discount, or
the portion of the total return on such obligation which bears the same ratio to such total return as the disqualified yield on such obligation bears to the yield to maturity on such obligation.
For purposes of clause (i), the term “disqualified yield” means the excess of the yield to maturity on the obligation over the sum referred to in subsection (i)(1)(B) plus 1 percentage point, and the term “total return” is the amount which would have been the original issue discount on the obligation if interest described in the parenthetical in section 1273(a)(2) were included in the stated redemption price at maturity.
This paragraph shall not apply to any obligation issued by any corporation for any period for which such corporation is an S corporation.
This paragraph shall not apply for purposes of determining earnings and profits; except that, for purposes of determining the dividend equivalent portion of any amount includible in gross income under section 1272(a) in respect of an applicable high yield discount obligation, no reduction shall be made for any amount attributable to the disqualified portion of any original issue discount on such obligation.
This paragraph shall not apply to any applicable high yield discount obligation issued during the period beginning on September 1, 2008, and ending on December 31, 2009, in exchange (including an exchange resulting from a modification of the debt instrument) for an obligation which is not an applicable high yield discount obligation and the issuer (or obligor) of which is the same as the issuer (or obligor) of such applicable high yield discount obligation. The preceding sentence shall not apply to any obligation the interest on which is interest described in section 871(h)(4) (without regard to subparagraph (D) thereof) or to any obligation issued to a related person (within the meaning of section 108(e)(4)).
Any obligation to which clause (i) applies shall not be treated as an applicable high yield discount obligation for purposes of applying this subparagraph to any other obligation issued in exchange for such obligation.
The Secretary may apply this paragraph with respect to debt instruments issued in periods following the period described in clause (i) if the Secretary determines that such application is appropriate in light of distressed conditions in the debt capital markets.
For definition of applicable high yield discount obligation, see subsection (i).
For provision relating to deduction of original issue discount on tax-exempt obligation, see section 1288.
For special rules in the case of the borrower under certain loans for personal use, see section 1275(b).
Nothing in subsection (a) or in any other provision of law shall be construed to provide a deduction for interest on any registration-required obligation unless such obligation is in registered form.
For purposes of this section—
The term “registration-required obligation” means any obligation (including any obligation issued by a governmental entity) other than an obligation which—
is issued by a natural person,
is not of a type offered to the public, or
has a maturity (at issue) of not more than 1 year.
Clauses (ii) and (iii) of subparagraph (A) shall not apply to any obligation if—
such obligation is of a type which the Secretary has determined by regulations to be used frequently in avoiding Federal taxes, and
such obligation is issued after the date on which the regulations referred to in clause (i) take effect.
For purposes of this subsection, rules similar to the rules of section 149(a)(3) shall apply, except that a dematerialized book entry system or other book entry system specified by the Secretary shall be treated as a book entry system described in such section.
The amount of the deduction under this section for interest paid or accrued during any taxable year on indebtedness with respect to which a mortgage credit certificate has been issued under section 25 shall be reduced by the amount of the credit allowable with respect to such interest under section 25 (determined without regard to section 26).
In the case of a taxpayer other than a corporation, no deduction shall be allowed under this chapter for personal interest paid or accrued during the taxable year.
For purposes of this subsection, the term “personal interest” means any interest allowable as a deduction under this chapter other than—
interest paid or accrued on indebtedness properly allocable to a trade or business (other than the trade or business of performing services as an employee),
any investment interest (within the meaning of subsection (d)),
any interest which is taken into account under section 469 in computing income or loss from a passive activity of the taxpayer,
any qualified residence interest (within the meaning of paragraph (3)),
any interest payable under section 6601 on any unpaid portion of the tax imposed by section 2001 for the period during which an extension of time for payment of such tax is in effect under section 6163, and
any interest allowable as a deduction under section 221 (relating to interest on educational loans).
For purposes of this subsection—
The term “qualified residence interest” means any interest which is paid or accrued during the taxable year on—
acquisition indebtedness with respect to any qualified residence of the taxpayer, or
home equity indebtedness with respect to any qualified residence of the taxpayer.
For purposes of the preceding sentence, the determination of whether any property is a qualified residence of the taxpayer shall be made as of the time the interest is accrued.
The term “acquisition indebtedness” means any indebtedness which—
is incurred in acquiring, constructing, or substantially improving any qualified residence of the taxpayer, and
is secured by such residence.
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).
Such term also includes any indebtedness secured by such residence resulting from the refinancing of indebtedness meeting the requirements of the preceding sentence (or this sentence); but only to the extent the amount of the indebtedness resulting from such refinancing does not exceed the amount of the refinanced indebtedness.
The term “home equity indebtedness” means any indebtedness (other than acquisition indebtedness) secured by a qualified residence to the extent the aggregate amount of such indebtedness does not exceed—
the fair market value of such qualified residence, reduced by
the amount of acquisition indebtedness with respect to such residence.
The aggregate amount treated as home equity indebtedness for any period shall not exceed $100,000 ($50,000 in the case of a separate return by a married individual).
In the case of any pre-
October 13, 1987
, indebtedness—
such indebtedness shall be treated as acquisition indebtedness, and
the limitation of subparagraph (B)(ii) shall not apply.
The limitation of subparagraph (B)(ii) shall be reduced (but not below zero) by the aggregate amount of outstanding pre-October 13, 1987, indebtedness.
The term “pre-
October 13, 1987
, indebtedness” means—
any indebtedness which was incurred on or before
October 13, 1987
, and which was secured by a qualified residence on
October 13, 1987
, and at all times thereafter before the interest is paid or accrued, or
any indebtedness which is secured by the qualified residence and was incurred after
October 13, 1987
, to refinance indebtedness described in subclause (I) (or refinanced indebtedness meeting the requirements of this subclause) to the extent (immediately after the refinancing) the principal amount of the indebtedness resulting from the refinancing does not exceed the principal amount of the refinanced indebtedness (immediately before the refinancing).
Subclause (II) of clause (iii) shall not apply to any indebtedness after—
the expiration of the term of the indebtedness described in clause (iii)(I), or
if the principal of the indebtedness described in clause (iii)(I) is not amortized over its term, the expiration of the term of the 1st refinancing of such indebtedness (or if earlier, the date which is 30 years after the date of such 1st refinancing).
Premiums paid or accrued for qualified mortgage insurance by a taxpayer during the taxable year in connection with acquisition indebtedness with respect to a qualified residence of the taxpayer shall be treated for purposes of this section as interest which is qualified residence interest.
The amount otherwise treated as interest under clause (i) shall be reduced (but not below zero) by 10 percent of such amount for each $1,000 ($500 in the case of a married individual filing a separate return) (or fraction thereof) that the taxpayer’s adjusted gross income for the taxable year exceeds $100,000 ($50,000 in the case of a married individual filing a separate return).
Clause (i) shall not apply with respect to any mortgage insurance contracts issued before January 1, 2007.
Clause (i) shall not apply to amounts—
paid or accrued after
December 31, 2021
, or
properly allocable to any period after such date.
In the case of taxable years beginning after
December 31, 2017
—
Subparagraph (A)(ii) shall not apply.
Subparagraph (B)(ii) shall be applied by substituting “$750,000 ($375,000” for “$1,000,000 ($500,000”.
Clause (iv) of subparagraph (E) shall not apply.
Subclause (II) shall not apply to any indebtedness incurred on or before December 15, 2017, and, in applying such subclause to any indebtedness incurred after such date, the limitation under such subclause shall be reduced (but not below zero) by the amount of any indebtedness incurred on or before December 15, 2017, which is treated as acquisition indebtedness for purposes of this subsection for the taxable year.
In the case of a taxpayer who enters into a written binding contract before December 15, 2017, to close on the purchase of a principal residence before January 1, 2018, and who purchases such residence before April 1, 2018, subclause (IV) shall be applied by substituting “April 1, 2018” for “December 15, 2017”.
In the case of any indebtedness which is incurred to refinance indebtedness, such refinanced indebtedness shall be treated for purposes of clause (i)(III) as incurred on the date that the original indebtedness was incurred to the extent the amount of the indebtedness resulting from such refinancing does not exceed the amount of the refinanced indebtedness.
Subclause (I) shall not apply to any indebtedness after the expiration of the term of the original indebtedness or, if the principal of such original indebtedness is not amortized over its term, the expiration of the term of the 1st refinancing of such indebtedness (or if earlier, the date which is 30 years after the date of such 1st refinancing).
Section 108(h)(2) shall be applied without regard to this subparagraph.
In the case of taxable years beginning after December 31, 2024, and before January 1, 2029, for purposes of this subsection the term “personal interest” shall not include qualified passenger vehicle loan interest.
For purposes of this paragraph, the term “qualified passenger vehicle loan interest” means any interest which is paid or accrued during the taxable year on indebtedness incurred by the taxpayer after December 31, 2024, for the purchase of, and that is secured by a first lien on, an applicable passenger vehicle for personal use.
Such term shall not include any amount paid or incurred on any of the following:
A loan to finance fleet sales.
A loan incurred for the purchase of a commercial vehicle that is not used for personal purposes.
Any lease financing.
A loan to finance the purchase of a vehicle with a salvage title.
A loan to finance the purchase of a vehicle intended to be used for scrap or parts.
Interest shall not be treated as qualified passenger vehicle loan interest under this paragraph unless the taxpayer includes the vehicle identification number of the applicable passenger vehicle described in clause (i) on the return of tax for the taxable year.
The amount of interest taken into account by a taxpayer under subparagraph (B) for any taxable year shall not exceed $10,000.
The amount which is otherwise allowable as a deduction under subsection (a) as qualified passenger vehicle loan interest (determined without regard to this clause and after the application of clause (i)) shall be reduced (but not below zero) by $200 for each $1,000 (or portion thereof) by which the modified adjusted gross income of the taxpayer for the taxable year exceeds $100,000 ($200,000 in the case of a joint return).
For purposes of this clause, the term “modified adjusted gross income” means the adjusted gross income of the taxpayer for the taxable year increased by any amount excluded from gross income under section 911, 931, or 933.
The term “applicable passenger vehicle” means any vehicle—
the original use of which commences with the taxpayer,
which is manufactured primarily for use on public streets, roads, and highways (not including a vehicle operated exclusively on a rail or rails),
which has at least 2 wheels,
which is a car, minivan, van, sport utility vehicle, pickup truck, or motorcycle,
which is treated as a motor vehicle for purposes of title II of the Clean Air Act, and
which has a gross vehicle weight rating of less than 14,000 pounds.
Such term shall not include any vehicle the final assembly of which did not occur within the United States.
For purposes of this paragraph—
For purposes of subparagraph (D), the term “final assembly” means the process by which a manufacturer produces a vehicle at, or through the use of, a plant, factory, or other place from which the vehicle is delivered to a dealer with all component parts necessary for the mechanical operation of the vehicle included with the vehicle, whether or not the component parts are permanently installed in or on the vehicle.
Indebtedness described in subparagraph (B) shall include indebtedness that results from refinancing any indebtedness described in such subparagraph, and that is secured by a first lien on the applicable passenger vehicle with respect to which the refinanced indebtedness was incurred, but only to the extent the amount of such resulting indebtedness does not exceed the amount of such refinanced indebtedness.
Indebtedness described in subparagraph (B) shall not include any indebtedness owed to a person who is related (within the meaning of section 267(b) or 707(b)(1)) to the taxpayer.
For purposes of this subsection—
The term “qualified residence” means—
the principal residence (within the meaning of section 121) of the taxpayer, and
1 other residence of the taxpayer which is selected by the taxpayer for purposes of this subsection for the taxable year and which is used by the taxpayer as a residence (within the meaning of section 280A(d)(1)).
If a married couple does not file a joint return for the taxable year—
such couple shall be treated as 1 taxpayer for purposes of clause (i), and
each individual shall be entitled to take into account 1 residence unless both individuals consent in writing to 1 individual taking into account the principal residence and 1 other residence.
For purposes of clause (i)(II), notwithstanding section 280A(d)(1), if the taxpayer does not rent a dwelling unit at any time during a taxable year, such unit may be treated as a residence for such taxable year.
Any indebtedness secured by stock held by the taxpayer as a tenant-stockholder (as defined in section 216) in a cooperative housing corporation (as so defined) shall be treated as secured by the house or apartment which the taxpayer is entitled to occupy as such a tenant-stockholder. If stock described in the preceding sentence may not be used to secure indebtedness, indebtedness shall be treated as so secured if the taxpayer establishes to the satisfaction of the Secretary that such indebtedness was incurred to acquire such stock.
Indebtedness shall not fail to be treated as secured by any property solely because, under any applicable State or local homestead or other debtor protection law in effect on August 16, 1986, the security interest is ineffective or the enforceability of the security interest is restricted.
For purposes of determining whether any interest paid or accrued by an estate or trust is qualified residence interest, any residence held by such estate or trust shall be treated as a qualified residence of such estate or trust if such estate or trust establishes that such residence is a qualified residence of a beneficiary who has a present interest in such estate or trust or an interest in the residuary of such estate or trust.
The term “qualified mortgage insurance” means—
mortgage insurance provided by the Department of Veterans Affairs, the Federal Housing Administration, or the Rural Housing Service, and
private mortgage insurance (as defined by section 2 of the Homeowners Protection Act of 1998 (
12 U.S.C. 4901
), as in effect on the date of the enactment of this subparagraph).
Any amount paid by the taxpayer for qualified mortgage insurance that is properly allocable to any mortgage the payment of which extends to periods that are after the close of the taxable year in which such amount is paid shall be chargeable to capital account and shall be treated as paid in such periods to which so allocated. No deduction shall be allowed for the unamortized balance of such account if such mortgage is satisfied before the end of its term. The preceding sentences shall not apply to amounts paid for qualified mortgage insurance provided by the Department of Veterans Affairs or the Rural Housing Service.
For purposes of this section, the term “applicable high yield discount obligation” means any debt instrument if—
the maturity date of such instrument is more than 5 years from the date of issue,
the yield to maturity on such instrument equals or exceeds the sum of—
the applicable Federal rate in effect under section 1274(d) for the calendar month in which the obligation is issued, plus
5 percentage points, and
such instrument has significant original issue discount.
For purposes of subparagraph (B)(i), the Secretary may by regulation (i) permit a rate to be used with respect to any debt instrument which is higher than the applicable Federal rate if the taxpayer establishes to the satisfaction of the Secretary that such higher rate is based on the same principles as the applicable Federal rate and is appropriate for the term of the instrument, or (ii) permit, on a temporary basis, a rate to be used with respect to any debt instrument which is higher than the applicable Federal rate if the Secretary determines that such rate is appropriate in light of distressed conditions in the debt capital markets.
For purposes of paragraph (1)(C), a debt instrument shall be treated as having significant original issue discount if—
the aggregate amount which would be includible in gross income with respect to such instrument for periods before the close of any accrual period (as defined in section 1272(a)(5)) ending after the date 5 years after the date of issue, exceeds—
the sum of—
the aggregate amount of interest to be paid under the instrument before the close of such accrual period, and
the product of the issue price of such instrument (as defined in sections 1273(b) and 1274(a)) and its yield to maturity.
For purposes of determining whether a debt instrument is an applicable high yield discount obligation—
any payment under the instrument shall be assumed to be made on the last day permitted under the instrument, and
any payment to be made in the form of another obligation of the issuer (or a related person within the meaning of section 453(f)(1)) shall be assumed to be made when such obligation is required to be paid in cash or in property other than such obligation.
Except for purposes of paragraph (1)(B), any reference to an obligation in subparagraph (B) of this paragraph shall be treated as including a reference to stock.
For purposes of this subsection, the term “debt instrument” means any instrument which is a debt instrument as defined in section 1275(a).
The Secretary shall prescribe such regulations as may be appropriate to carry out the purposes of this subsection and subsection (e)(5), including—
regulations providing for modifications to the provisions of this subsection and subsection (e)(5) in the case of varying rates of interest, put or call options, indefinite maturities, contingent payments, assumptions of debt instruments, conversion rights, or other circumstances where such modifications are appropriate to carry out the purposes of this subsection and subsection (e)(5), and
regulations to prevent avoidance of the purposes of this subsection and subsection (e)(5) through the use of issuers other than C corporations, agreements to borrow amounts due under the debt instrument, or other arrangements.
The amount allowed as a deduction under this chapter for any taxable year for business interest shall not exceed the sum of—
the business interest income of such taxpayer for such taxable year,
30 percent of the adjusted taxable income of such taxpayer for such taxable year, plus
the floor plan financing interest of such taxpayer for such taxable year.
The amount determined under subparagraph (B) shall not be less than zero.
The amount of any business interest not allowed as a deduction for any taxable year by reason of paragraph (1) shall be treated as business interest paid or accrued in the succeeding taxable year.
In the case of any taxpayer (other than a tax shelter prohibited from using the cash receipts and disbursements method of accounting under section 448(a)(3)) which meets the gross receipts test of section 448(c) for any taxable year, paragraph (1) shall not apply to such taxpayer for such taxable year. In the case of any taxpayer which is not a corporation or a partnership, the gross receipts test of section 448(c) shall be applied in the same manner as if such taxpayer were a corporation or partnership.
In the case of any partnership—
this subsection shall be applied at the partnership level and any deduction for business interest shall be taken into account in determining the non-separately stated taxable income or loss of the partnership, and
the adjusted taxable income of each partner of such partnership—
shall be determined without regard to such partner’s distributive share of any items of income, gain, deduction, or loss of such partnership, and
shall be increased by such partner’s distributive share of such partnership’s excess taxable income.
For purposes of clause (ii)(II), a partner’s distributive share of partnership excess taxable income shall be determined in the same manner as the partner’s distributive share of nonseparately stated taxable income or loss of the partnership.
The amount of any business interest not allowed as a deduction to a partnership for any taxable year by reason of paragraph (1) for any taxable year—
shall not be treated under paragraph (2) as business interest paid or accrued by the partnership in the succeeding taxable year, and
shall, subject to clause (ii), be treated as excess business interest which is allocated to each partner in the same manner as the non-separately stated taxable income or loss of the partnership.
If a partner is allocated any excess business interest from a partnership under clause (i) for any taxable year—
such excess business interest shall be treated as business interest paid or accrued by the partner in the next succeeding taxable year in which the partner is allocated excess taxable income from such partnership, but only to the extent of such excess taxable income, and
any portion of such excess business interest remaining after the application of subclause (I) shall, subject to the limitations of subclause (I), be treated as business interest paid or accrued in succeeding taxable years.
The adjusted basis of a partner in a partnership interest shall be reduced (but not below zero) by the amount of excess business interest allocated to the partner under clause (i)(II).
If a partner disposes of a partnership interest, the adjusted basis of the partner in the partnership interest shall be increased immediately before the disposition by the amount of the excess (if any) of the amount of the basis reduction under subclause (I) over the portion of any excess business interest allocated to the partner under clause (i)(II) which has previously been treated under clause (ii) as business interest paid or accrued by the partner. The preceding sentence shall also apply to transfers of the partnership interest (including by reason of death) in a transaction in which gain is not recognized in whole or in part. No deduction shall be allowed to the transferor or transferee under this chapter for any excess business interest resulting in a basis increase under this subclause.
For purposes of applying this paragraph, excess taxable income allocated to a partner from a partnership for any taxable year shall not be taken into account under paragraph (1)(A) with respect to any business interest other than excess business interest from the partnership until all such excess business interest for such taxable year and all preceding taxable years has been treated as paid or accrued under clause (ii).
The term “excess taxable income” means, with respect to any partnership, the amount which bears the same ratio to the partnership’s adjusted taxable income as—
the excess (if any) of—
the amount determined for the partnership under paragraph (1)(B), over
the amount (if any) by which the business interest of the partnership, reduced by the floor plan financing interest, exceeds the business interest income of the partnership, bears to
the amount determined for the partnership under paragraph (1)(B).
Rules similar to the rules of subparagraphs (A) and (C) shall apply with respect to any S corporation and its shareholders.
For purposes of this subsection, the term “business interest” means any interest paid or accrued on indebtedness properly allocable to a trade or business. Such term shall not include investment interest (within the meaning of subsection (d)). Such term shall not include any interest which is capitalized under section 263(g) or 263A(f).
For purposes of this subsection, the term “business interest income” means the amount of interest includible in the gross income of the taxpayer for the taxable year which is properly allocable to a trade or business. Such term shall not include investment income (within the meaning of subsection (d)).
For purposes of this subsection—
The term “trade or business” shall not include—
the trade or business of performing services as an employee,
any electing real property trade or business,
any electing farming business, or
the trade or business of the furnishing or sale of—
electrical energy, water, or sewage disposal services,
gas or steam through a local distribution system, or
transportation of gas or steam by pipeline,
if the rates for such furnishing or sale, as the case may be, have been established or approved by a State or political subdivision thereof, by any agency or instrumentality of the United States, by a public service or public utility commission or other similar body of any State or political subdivision thereof, or by the governing or ratemaking body of an electric cooperative.
For purposes of this paragraph, the term “electing real property trade or business” means any trade or business which is described in section 469(c)(7)(C) and which makes an election under this subparagraph. Any such election shall be made at such time and in such manner as the Secretary shall prescribe, and, once made, shall be irrevocable.
For purposes of this paragraph, the term “electing farming business” means—
a farming business (as defined in section 263A(e)(4)) which makes an election under this subparagraph, or
any trade or business of a specified agricultural or horticultural cooperative (as defined in section 199A(g)(2))
1
1 See References in Text note below.
with respect to which the cooperative makes an election under this subparagraph.
Any such election shall be made at such time and in such manner as the Secretary shall prescribe, and, once made, shall be irrevocable.
For purposes of this subsection, the term “adjusted taxable income” means the taxable income of the taxpayer—
computed without regard to—
any item of income, gain, deduction, or loss which is not properly allocable to a trade or business,
any business interest or business interest income,
the amount of any net operating loss deduction under section 172,
the amount of any deduction allowed under section 199A,
any deduction allowable for depreciation, amortization, or depletion, and
the amounts included in gross income under sections 951(a), 951A(a), and 78 (and the portion of the deductions allowed under sections 245A(a) (by reason of section 964(e)(4)) and 250(a)(1)(B) by reason of such inclusions), and
computed with such other adjustments as provided by the Secretary.
For purposes of this subsection—
The term “floor plan financing interest” means interest paid or accrued on floor plan financing indebtedness.
The term “floor plan financing indebtedness” means indebtedness—
used to finance the acquisition of motor vehicles held for sale or lease, and
secured by the inventory so acquired.
The term “motor vehicle” means a motor vehicle that is any of the following:
Any self-propelled vehicle designed for transporting persons or property on a public street, highway, or road.
A boat.
Farm machinery or equipment.
Such term shall also include any trailer or camper which is designed to provide temporary living quarters for recreational, camping, or seasonal use and is designed to be towed by, or affixed to, a motor vehicle.
In applying this subsection—
the limitation under paragraph (1) shall apply to business interest without regard to whether the taxpayer would otherwise deduct such business interest or capitalize such business interest under an interest capitalization provision, and
any reference in this subsection to a deduction for business interest shall be treated as including a reference to the capitalization of business interest.
The amount allowed after taking into account the limitation described in paragraph (1)—
shall be applied first to the aggregate amount of business interest which would otherwise be capitalized, and
the remainder (if any) shall be applied to the aggregate amount of business interest which would be deducted.
No portion of any business interest carried forward under paragraph (2) from any taxable year to any succeeding taxable year shall, for purposes of this title (including any interest capitalization provision which previously applied to such portion) be treated as interest to which an interest capitalization provision applies.
For purposes of this section, the term “interest capitalization provision” means any provision of this subtitle under which interest—
is required to be charged to capital account, or
may be deducted or charged to capital account.
The Secretary shall issue such regulations or guidance as may be necessary or appropriate to carry out the purposes of this subsection, including regulations or guidance to determine which business interest is taken into account under this subsection and section 59A(c)(3).
Except as provided in clause (ii) or (iii), in the case of any taxable year beginning in 2019 or 2020, paragraph (1)(B) shall be applied by substituting “50 percent” for “30 percent”.
In the case of a partnership—
clause (i) shall not apply to any taxable year beginning in 2019, but
unless a partner elects not to have this subclause apply, in the case of any excess business interest of the partnership for any taxable year beginning in 2019 which is allocated to the partner under paragraph (4)(B)(i)(II)—
50 percent of such excess business interest shall be treated as business interest which, notwithstanding paragraph (4)(B)(ii), is paid or accrued by the partner in the partner’s first taxable year beginning in 2020 and which is not subject to the limits of paragraph (1), and
50 percent of such excess business interest shall be subject to the limitations of paragraph (4)(B)(ii) in the same manner as any other excess business interest so allocated.
A taxpayer may elect, at such time and in such manner as the Secretary may prescribe, not to have clause (i) apply to any taxable year. Such an election, once made, may be revoked only with the consent of the Secretary. In the case of a partnership, any such election shall be made by the partnership and may be made only for taxable years beginning in 2020.
Subject to clause (ii), in the case of any taxable year beginning in 2020, the taxpayer may elect to apply this subsection by substituting the adjusted taxable income of the taxpayer for the last taxable year beginning in 2019 for the adjusted taxable income for such taxable year. In the case of a partnership, any such election shall be made by the partnership.
If an election is made under clause (i) for a taxable year which is a short taxable year, the adjusted taxable income for the taxpayer’s last taxable year beginning in 2019 which is substituted under clause (i) shall be equal to the amount which bears the same ratio to such adjusted taxable income determined without regard to this clause as the number of months in the short taxable year bears to 12 22 So in original. Probably should be followed by a period.
For requirement that an electing real property trade or business use the alternative depreciation system, see section 168(g)(1)(F).
For requirement that an electing farming business use the alternative depreciation system, see section 168(g)(1)(G).
No deduction shall be allowed under this section for any interest payable under section 6601 on any unpaid portion of the tax imposed by section 2001 for the period during which an extension of time for payment of such tax is in effect under section 6166.
No deduction shall be allowed under this chapter for any interest paid or accrued on a disqualified debt instrument.
For purposes of this subsection, the term “disqualified debt instrument” means any indebtedness of a corporation which is payable in equity of the issuer or a related party or equity held by the issuer (or any related party) in any other person.
For purposes of paragraph (2), indebtedness shall be treated as payable in equity of the issuer or any other person only if—
a substantial amount of the principal or interest is required to be paid or converted, or at the option of the issuer or a related party is payable in, or convertible into, such equity,
a substantial amount of the principal or interest is required to be determined, or at the option of the issuer or a related party is determined, by reference to the value of such equity, or
the indebtedness is part of an arrangement which is reasonably expected to result in a transaction described in subparagraph (A) or (B).
For purposes of this paragraph, principal or interest shall be treated as required to be so paid, converted, or determined if it may be required at the option of the holder or a related party and there is a substantial certainty the option will be exercised.
If the disqualified debt instrument of a corporation is payable in equity held by the issuer (or any related party) in any other person (other than a related party), the basis of such equity shall be increased by the amount not allowed as a deduction by reason of paragraph (1) with respect to the instrument.
For purposes of this subsection, the term “disqualified debt instrument” does not include indebtedness issued by a dealer in securities (or a related party) which is payable in, or by reference to, equity (other than equity of the issuer or a related party) held by such dealer in its capacity as a dealer in securities. For purposes of this paragraph, the term “dealer in securities” has the meaning given such term by section 475.
For purposes of this subsection, a person is a related party with respect to another person if such person bears a relationship to such other person described in section 267(b) or 707(b).
The Secretary shall prescribe such regulations as may be necessary or appropriate to carry out the purposes of this subsection, including regulations preventing avoidance of this subsection through the use of an issuer other than a corporation.
No deduction shall be allowed under this chapter for any interest paid or accrued under section 6601 on any underpayment of tax which is attributable to the portion of any reportable transaction understatement (as defined in section 6662A(b)) with respect to which the requirement of section 6664(d)(2)(A) 1 is not met.
For disallowance of certain amounts paid in connection with insurance, endowment, or annuity contracts, see section 264.
For disallowance of deduction for interest relating to tax-exempt income, see section 265(a)(2).
For disallowance of deduction for carrying charges chargeable to capital account, see section 266.
For disallowance of interest with respect to transactions between related taxpayers, see section 267.
For treatment of redeemable ground rents and real property held subject to liabilities under redeemable ground rents, see section 1055.
Treasury Regulations
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Treas. Reg. §1.163-1Interest deduction in general
(a) Except as otherwise provided in sections 264 to 267, inclusive, interest paid or accrued within the taxable year on indebtedness shall be allowed as a deduction in computing taxable income. For rules relating to interest on certain deferred payments, see section 483 and the regulations thereunder.
(b) Interest paid by the taxpayer on a mortgage upon real estate of which he is the legal or equitable owner, even though the taxpayer is not directly liable upon the bond or note secured by such mortgage, may be deducted as interest on his indebtedness. Pursuant to the provisions of section 163(c), any annual or periodic rental payment made by a taxpayer on or after January 1, 1962, under a redeemable ground rent, as defined in section 1055(c) and paragraph (b) of § 1.1055-1, is required to be treated as interest on an indebtedness secured by a mortgage and, accordingly, may be deducted by the taxpayer as interest on his indebtedness. Section 163(c) has no application in respect of any annual or periodic rental payment made prior to January 1, 1962, or pursuant to an arrangement which does not constitute a “redeemable ground rent” as defined in section 1055(c) and paragraph (b) of § 1.1055-1. Accordingly, annual or periodic payments of Pennsylvania ground rents made before, on, or after January 1, 1962, are deductible as interest if the ground rent is redeemable. An annual or periodic rental payment under a Maryland redeemable ground rent made prior to January 1, 1962, is deductible in accordance with the rules and regulations applicable at the time such payment was made. Any annual or periodic rental payment under a Maryland redeemable ground rent made by the taxpayer on or after January 1, 1962, is, pursuant to the provisions of section 163(c), treated as interest on an indebtedness secured by a mortgage and, accordingly, is deductible by the taxpayer as interest on his indebtedness. In any case where the ground rent is irredeemable, any annual or periodic ground rent payment shall be treated as rent and shall be deductible only to the extent that the payment constitutes a proper business expense. Amounts paid in redemption of a ground rent shall not be treated as interest. For treatment of redeemable ground rents and real property held subject to liabilities under redeemable ground rents, see section 1055 and the regulations thereunder.
(c) Interest calculated for costkeeping or other purposes on account of capital or surplus invested in the business which does not represent a charge arising under an interest-bearing obligation, is not an allowable deduction from gross income. Interest paid by a corporation on scrip dividends is an allowable deduction. So-called interest on preferred stock, which is in reality a dividend thereon, cannot be deducted in computing taxable income. (See, however, section 583.) In the case of banks and loan or trust companies, interest paid within the year on deposits, such as interest paid on moneys received for investment and secured by interest-bearing certificates of indebtedness issued by such bank or loan or trust company, may be deducted from gross income.
(d) To the extent of assistance payments made in respect of an indebtedness of the taxpayer during the taxable year by the Department of Housing and Urban Development under section 235 of the National Housing Act (12 U.S.C. 1715z), as amended, no deduction shall be allowed under section 163 and this section for interest paid or accrued with respect to such indebtedness. However, such payments shall not affect the amount of any deduction under any section of the Code other than section 163. The provisions of this paragraph shall apply to taxable years beginning after December 31, 1974.
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Treas. Reg. §1.163-1(a)Except as otherwise provided in sections 264 to 267, inclusive, interest paid or accrued within the taxable year on indebtedness shall be allowed as a deduction in computing taxable income.
Except as otherwise provided in sections 264 to 267, inclusive, interest paid or accrued within the taxable year on indebtedness shall be allowed as a deduction in computing taxable income. For rules relating to interest on certain deferred payments, see section 483 and the regulations thereunder.
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Treas. Reg. §1.163-1(b)Interest paid by the taxpayer on a mortgage upon real estate of which he is the legal or equitable owner, even though the taxpayer is not directly liable upon the bond or note secured by such mortgage, may be deducted as interest on his indebtedness.
Interest paid by the taxpayer on a mortgage upon real estate of which he is the legal or equitable owner, even though the taxpayer is not directly liable upon the bond or note secured by such mortgage, may be deducted as interest on his indebtedness. Pursuant to the provisions of section 163(c), any annual or periodic rental payment made by a taxpayer on or after January 1, 1962, under a redeemable ground rent, as defined in section 1055(c) and paragraph (b) of § 1.1055-1, is required to be treated as interest on an indebtedness secured by a mortgage and, accordingly, may be deducted by the taxpayer as interest on his indebtedness. Section 163(c) has no application in respect of any annual or periodic rental payment made prior to January 1, 1962, or pursuant to an arrangement which does not constitute a “redeemable ground rent” as defined in section 1055(c) and paragraph (b) of § 1.1055-1. Accordingly, annual or periodic payments of Pennsylvania ground rents made before, on, or after January 1, 1962, are deductible as interest if the ground rent is redeemable. An annual or periodic rental payment under a Maryland redeemable ground rent made prior to January 1, 1962, is deductible in accordance with the rules and regulations applicable at the time such payment was made. Any annual or periodic rental payment under a Maryland redeemable ground rent made by the taxpayer on or after January 1, 1962, is, pursuant to the provisions of section 163(c), treated as interest on an indebtedness secured by a mortgage and, accordingly, is deductible by the taxpayer as interest on his indebtedness. In any case where the ground rent is irredeemable, any annual or periodic ground rent payment shall be treated as rent and shall be deductible only to the extent that the payment constitutes a proper business expense. Amounts paid in redemption of a ground rent shall not be treated as interest. For treatment of redeemable ground rents and real property held subject to liabilities under redeemable ground rents, see section 1055 and the regulations thereunder.
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Treas. Reg. §1.163-1(c)Interest calculated for costkeeping or other purposes on account of capital or surplus invested in the business which does not represent a charge arising under an interest-bearing obligation, is not an allowable deduction from gross income.
Interest calculated for costkeeping or other purposes on account of capital or surplus invested in the business which does not represent a charge arising under an interest-bearing obligation, is not an allowable deduction from gross income. Interest paid by a corporation on scrip dividends is an allowable deduction. So-called interest on preferred stock, which is in reality a dividend thereon, cannot be deducted in computing taxable income. (See, however, section 583.) In the case of banks and loan or trust companies, interest paid within the year on deposits, such as interest paid on moneys received for investment and secured by interest-bearing certificates of indebtedness issued by such bank or loan or trust company, may be deducted from gross income.
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Treas. Reg. §1.163-1(d)To the extent of assistance payments made in respect of an indebtedness of the taxpayer during the taxable year by the Department of Housing and Urban Development under section 235 of the National Housing Act (12 U.
To the extent of assistance payments made in respect of an indebtedness of the taxpayer during the taxable year by the Department of Housing and Urban Development under section 235 of the National Housing Act (12 U.S.C. 1715z), as amended, no deduction shall be allowed under section 163 and this section for interest paid or accrued with respect to such indebtedness. However, such payments shall not affect the amount of any deduction under any section of the Code other than section 163. The provisions of this paragraph shall apply to taxable years beginning after December 31, 1974.
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Treas. Reg. §1.163-10TQualified residence interest
(a) Table of contents. This paragraph (a) lists the major paragraphs that appear in this § 1.163-10T.
(a) Table of contents.
(b) Treatment of qualified residence interest.
(c) Determination of qualified residence interest when secured debt does not exceed the adjusted purchase price.
(1) In general.
(2) Examples.
(d) Determination of qualified residence interest when secured debt exceeds adjusted purchase price—Simplified method.
(1) In general.
(2) Treatment of interest paid or accrued on secured debt that is not qualified residence interest.
(3) Example.
(e) Determination of qualified residence interest when secured debt exceeds adjusted purchase price—Exact method.
(1) In general.
(2) Determination of applicable debt limit.
(3) Example.
(4) Treatment of interest paid or accrued with respect to secured debt that is not qualified residence interest.
(i) In general.
(ii) Example.
(iii) Special rule of debt is allocated to more than one expenditure.
(iv) Example.
(f) Special rules.
(1) Special rules for personal property.
(i) In general.
(ii) Example.
(2) Special rule for real property.
(i) In general.
(ii) Example.
(g) Selection of method.
(h) Average balance.
(1) Average balance defined.
(2) Average balance reported by lender.
(3) Average balance computed on a daily basis.
(i) In general.
(ii) Example.
(4) Average balance computed using the interest rate.
(i) In general.
(ii) Points and prepaid interest.
(iii) Examples.
(5) Average balance computed using average of beginning and ending balance.
(i) In general.
(ii) Example.
(6) Highest principal balance.
(7) Other methods provided by the Commissioner.
(8) Anti-abuse rule.
(i) [Reserved]
(j) Determination of interest paid or accrued during the taxable year.
(1) In general.
(2) Special rules for cash-basis taxpayers.
(i) Points deductible in year paid under section 461(g)(2).
(ii) Points and other prepaid interest described in section 461(g)(1).
(3) Examples.
(k) Determination of adjusted purchase price and fair market value.
(1) Adjusted purchase price.
(i) In general.
(ii) Adjusted purchase price of a qualified residence acquired incident to divorce.
(iii) Examples.
(2) Fair market value.
(i) In general.
(ii) Examples.
(3) Allocation of adjusted purchase price and fair market value.
(l) [Reserved]
(m) Grandfathered amount.
(1) Substitution for adjusted purchase price.
(2) Determination of grandfathered amount.
(i) In general.
(ii) Special rule for lines of credit and certain other debt.
(iii) Fair market value limitation.
(iv) Examples.
(3) Refinancing of grandfathered debt.
(i) In general.
(ii) Determination of grandfathered amount.
(4) Limitation on terms of grandfathered debt.
(i) In general.
(ii) Special rule for nonamortizing debt.
(iii) Example.
(n) Qualified indebtedness (secured debt used for medical and educational purposes).
(1) In general.
(i) Treatment of qualified indebtedness.
(ii) Determination of amount of qualified indebtedness.
(iii) Determination of amount of qualified indebtedness for mixed-use debt.
(iv) Example.
(v) Prevention of double counting in year of refinancing.
(vi) Special rule for principal payments in excess of qualified expenses.
(2) Debt used to pay for qualified medical or educational expenses.
(i) In general.
(ii) Special rule for refinancing.
(iii) Other special rules.
(iv) Examples.
(3) Qualified medical expenses.
(4) Qualified educational expenses.
(o) Secured debt.
(1) In general.
(2) Special rule for debt in certain States.
(3) Time at which debt is treated as secured.
(4) Partially secured debt.
(i) In general.
(ii) Example.
(5) Election to treat debt as not secured by a qualified residence.
(i) In general.
(ii) Example.
(iii) Allocation of debt secured by two qualified residences.
(p) Definition of qualified residence.
(1) In general.
(2) Principal residence.
(3) Second residence.
(i) In general.
(ii) Definition of residence.
(iii) Use as a residence.
(iv) Election of second residence.
(4) Allocations between residence and other property.
(i) In general.
(ii) Special rule for rental of residence.
(iii) Examples.
(5) Residence under construction.
(i) In general.
(ii) Example.
(6) Special rule for the time-sharing arrangements.
(q) Special rules for tenant-stockholders in cooperative housing corporations.
(1) In general.
(2) Special rule where stock may not be used to secure debt.
(3) Treatment of interest expense of the cooperative described in section 216(a)(2).
(4) Special rule to prevent tax avoidance.
(5) Other definitions.
(r) Effective date.
(b) Treatment of qualified residence interest. Except as provided below, qualified residence interest is deductible under section 163(a). Qualified residence interest is not subject to limitation or otherwise taken into account under section 163(d) (limitation on investment interest), section 163(h)(1) (disallowance of deduction for personal interest), section 263A (capitalization and inclusion in inventory costs of certain expenses) or section 469 (limitations on losses from passive activities). Qualified residence interest is subject to the limitation imposed by section 263(g) (certain interest in the case of straddles), section 264(a) (2) and (4) (interest paid in connection with certain insurance), section 265(a)(2) (interest relating to tax-exempt income), section 266 (carrying charges), section 267(a)(2) (interest with respect to transactions between related taxpayers) section 465 (deductions limited to amount at risk), section 1277 (deferral of interest deduction allocable to accrued market discount), and section 1282 (deferral of interest deduction allocable to accrued discount).
(c) Determination of qualified residence interest when secured debt does not exceed adjusted purchase price—(1) In general. If the sum of the average balances for the taxable year of all secured debts on a qualified residence does not exceed the adjusted purchase price (determined as of the end of the taxable year) of the qualified residence, all of the interest paid or accrued during the taxable year with respect to the secured debts is qualified residence interest. If the sum of the average balances for the taxable year of all secured debts exceeds the adjusted purchase price of the qualified residences (determined as of the end of the taxable year), the taxpayer must use either the simplified method (see paragraph (d) of this section) or the exact method (see paragraph (e) of this section) to determine the amount of interest that is qualified residence interest.
(2) Examples.
(d) Determination of qualified residence interest when secured debt exceeds adjusted purchase price—Simplified method—(1) In general. Under the simplified method, the amount of qualified residence interest for the taxable year is equal to the total interest paid or accrued during the taxable year with respect to all secured debts multiplied by a fraction (not in excess of one), the numerator of which is the adjusted purchase price (determined as of the end of the taxable year) of the qualified residence and the denominator of which is the sum of the average balances of all secured debts.
(2) Treatment of interest paid or accrued on secured debt that is not qualified residence interest. Under the simplified method, the excess of the total interest paid or accrued during the taxable year with respect to all secured debts over the amount of qualified residence interest is personal interest.
(3) Example.
(e) Determination of qualified residence interest when secured debt exceeds adjusted purchase price—Exact method—(1) In general. Under the exact method, the amount of qualified residence interest for the taxable year is determined on a debt-by-debt basis by computing the applicable debt limit for each secured debt and comparing each such applicable debt limit to the average balance of the corresponding debt. If, for the taxable year, the average balance of a secured debt does not exceed the applicable debt limit for that debt, all of the interest paid or accrued during the taxable year with respect to the debt is qualified residence interest. If the average balance of the secured debt exceeds the applicable debt limit for that debt, the amount of qualified residence interest with respect to the debt is determined by multiplying the interest paid or accrued with respect to the debt by a fraction, the numerator of which is the applicable debt limit for that debt and the denominator of which is the average balance of the debt.
(2) Determination of applicable debt limit. For each secured debt, the applicable debt limit for the taxable year is equal to
(i) The lesser of—
(A) The fair market value of the qualified residence as of the date the debt is first secured, and
(B) The adjusted purchase price of the qualified residence as of the end of the taxable year,
(ii) Reduced by the average balance of each debt previously secured by the qualified residence.
For purposes of paragraph (e)(2)(ii) of this section, the average balance of a debt shall be treated as not exceeding the applicable debt limit of such debt. See paragraph (n)(1)(i) of this section for the rule that increases the adjusted purchase price in paragraph (e)(2)(i)(B) of this section by the amount of any qualified indebtedness (certain medical and educational debt). See paragraph (f) of this section for special rules relating to the determination of the fair market value of the qualified residence.
(3) Example. (i) R's principal residence has an adjusted purchase price on December 31, 1988, of $105,000. R has two debts secured by the residence. The average balances and interest payments on each debt during 1988 and fair market value of the residence on the date each debt was secured are as follows:
(ii) The amount of qualified residence interest for 1988 under the exact method is determined as follows. Because there are no debts previously secured by the residence, the applicable debt limit for Debt 1 is $100,000 (the lesser of the adjusted purchase price as of the end of the taxable year and the fair market value of the residence at the time the debt was secured). Because the average balance of Debt 1 ($80,000) does not exceed its applicable debt limit ($100,000), all of the interest paid on the debt during 1988 ($8,000) is qualified residence interest.
(iii) The applicable debt limit for Debt 2 is $25,000 ($105,000 (the lesser of $140,000 fair market value and $105,000 adjusted purchase price) reduced by $80,000 (the average balance of Debt 1)). Because the average balance of Debt 2 ($40,000) exceeds its applicable debt limit, the amount of qualified residence interest on Debt 2 is determined by multiplying the amount of interest paid on the debt during the year ($4,800) by a fraction equal to its applicable debt limit divided by its average balance ($25,000/$40,000 = 0.625). Accordingly, $3,000 ($4,800 × 0.625) of the interest paid in 1988 on Debt 2 is qualified residence interest. The character of the remaining $1,800 of interest paid on Debt 2 is determined under the rules of paragraph (e)(4) of this section.
(4) Treatment of interest paid or accrued with respect to secured debt that is not qualified residence interest—(i) In general. Under the exact method, the excess of the interest paid or accrued during the taxable year with respect to a secured debt over the amount of qualified residence interest with respect to the debt is allocated under the rules of § 1.163-8T.
(ii) Example. T borrows $20,000 and the entire proceeds of the debt are disbursed by the lender to T's broker to purchase securities held for investment. T secures the debt with T's principal residence. In 1990, T pays $2,000 of interest on the debt. Assume that under the rules of paragraph (e) of this section, $1,500 of the interest is qualified residence interest. The remaining $500 in interest expense would be allocated under the rules of § 1.163-8T. Section 1.163-8T generally allocates debt (and the associated interest expense) by tracing disbursements of the debt proceeds to specific expenditures. Accordingly, the $500 interest expense on the debt that is not qualified residence interest is investment interest subject to section 163(d).
(iii) Special rule if debt is allocated to more than one expenditure. If—
(A) The average balance of a secured debt exceeds the applicable debt limit for that debt, and
(B) Under the rules of § 1.163-8T, interest paid or accrued with respect to such debt is allocated to more than one expenditure,
the interest expense that is not qualified residence interest may be allocated among such expenditures, to the extent of such expenditures, in any manner selected by the taxpayer.
(iv) Example. (i) C borrows $60,000 secured by a qualified residence. C uses (within the meaning of § 1.163-8T) $20,000 of the proceeds in C's trade or business, $20,000 to purchase stock held for investment and $20,000 for personal purposes. In 1990, C pays $6,000 in interest on the debt and, under the rules of § 1.163-8T, $2,000 in interest is allocable to trade or business expenses, $2,000 to investment expenses and $2,000 to personal expenses. Assume that under paragraph (e) of this section, $2,500 of the interest is qualified residence interest and $3,500 of the interest is not qualified residence interest.
(ii) Under paragraph (e)(4)(iii) of this section, C may allocate up to $2,000 of the interest that is not qualified residence interest to any of the three categories of expenditures up to a total of $3,500 for all three categories. Therefore, for example, C may allocate $2,000 of such interest to C's trade or business and $1,500 of such interest to the purchase of stock.
(f) Special rules—(1) Special rules for personal property—(i) In general. If a qualified residence is personal property under State law (e.g., a boat or motorized vehicle)—
(A) For purposes of paragraphs (c)(1) and (d)(1) of this section, if the fair market value of the residence as of the date that any secured debt (outstanding during the taxable year) is first secured by the residence is less than the adjusted purchase price as of the end of the taxable year, the lowest such fair market value shall be substituted for the adjusted purchase price.
(B) For purposes of paragraphs (e)(2)(i)(A) and (f)(1)(i)(A) of this section, the fair market value of the residence as of the date the debt is first secured by the residence shall not exceed the fair market value as of any date on which the taxpayer borrows any additional amount with respect to the debt.
(ii) Example. D owns a recreational vehicle that is a qualified residence under paragraph (p)(4) of this section. The adjusted purchase price and fair market value of the recreational vehicle is $20,000 in 1989. In 1989, D establishes a line of credit secured by the recreational vehicle. As of June 1, 1992, the fair market value of the vehicle has decreased to $10,000. On that day, D borrows an additional amount on the debt by using the line of credit. Although under paragraphs (e)(2)(i) and (f)(1)(i)(A) of this section, fair market value is determined at the time the debt is first secured, under paragraph (f)(1)(i)(B) of this section, the fair market value is the lesser of that amount or the fair market value on the most recent date that D borrows any additional amount with respect to the line of credit. Therefore, the fair market value with respect to the debt is $10,000.
(2) Special rule for real property—(i) In general. For purposes of paragraph (e)(2)(i)(A) of this section, the fair market value of a qualified residence that is real property under State law is presumed irrebuttably to be not less than the adjusted purchase price of the residence as of the last day of the taxable year.
(ii) Example. (i) C purchases a residence on August 11, 1987, for $50,000, incurring a first mortgage. The residence is real property under State law. During 1987, C makes $10,000 in home improvements. Accordingly, the adjusted purchase price of the residence as of December 31, 1988, is $60,000. C incurs a second mortgage on May 19, 1988, as of which time the fair market value of the residence is $55,000.
(ii) For purposes of determining the applicable debt limit for each debt, the fair market value of the residence is generally determined as of the time the debt is first secured. Accordingly, the fair market value would be $50,000 and $55,000 with respect to the first and second mortgage, respectively. Under the special rule of paragraph (f)(2)(i) of this section, however, the fair market value with respect to both debts in 1988 is $60,000, the adjusted purchase price on December 31, 1988.
(g) Selection of method. For any taxable year, a taxpayer may use the simplified method (described in paragraph (d) of this section) or the exact method (described in paragraph (e) of this section) by completing the appropriate portion of Form 8598. A taxpayer with two qualified residences may use the simplified method for one residence and the exact method for the other residence.
(h) Average balance—(1) Average balance defined. For purposes of this section, the term “average balance” means the amount determined under this paragraph (h). A taxpayer is not required to use the same method to determine the average balance of all secured debts during a taxable year or of any particular secured debt from one year to the next.
(2) Average balance reported by lender. If a lender that is subject to section 6050H (returns relating to mortgage interest received in trade or business from individuals) reports the average balance of a secured debt on Form 1098, the taxpayer may use the average balance so reported.
(3) Average balance computed on a daily basis—(i) In general. The average balance may be determined by—
(A) Adding the outstanding balance of a debt on each day during the taxable year that the debt is secured by a qualified residence, and
(B) Dividing the sum by the number of days during the taxable year that the residence is a qualified residence.
(ii) Example. Taxpayer A incurs a debt of $10,000 on September 1, 1989, securing the debt with A's principal residence. The residence is A's principal residence during the entire taxable year. A pays current interest on the debt monthly, but makes no principal payments. The debt is, therefore, outstanding for 122 days with a balance each day of $10,000. The residence is a qualified residence for 365 days. The average balance of the debt for 1989 is $3,342 (122 × $10,000/365).
(4) Average balance computed using the interest rate—(i) In general. If all accrued interest on a secured debt is paid at least monthly, the average balance of the secured debt may be determined by dividing the interest paid or accrued during the taxable year while the debt is secured by a qualified residence by the annual interest rate on the debt. If the interest rate on a debt varies during the taxable year, the lowest annual interest rate that applies to the debt during the taxable year must be used for purposes of this paragraph (h)(4). If the residence securing the debt is a qualified residence for less than the entire taxable year, the average balance of any secured debt may be determined by dividing the average balance determined under the preceding sentence by the percentage of the taxable year that the debt is secured by a qualified residence.
(ii) Points and prepaid interest. For purposes of paragraph (h)(4)(i) of this section, the amount of interest paid during the taxable year does not include any amount paid as points and includes prepaid interest only in the year accrued.
(iii) Examples.
(5) Average balance computed using average of beginning and ending balances—(i) In general. If—
(A) A debt requires level payments at fixed equal intervals (e.g., monthly, quarterly) no less often than semi-annually during the taxable year,
(B) The taxpayer prepays no more than one month's principal on the debt during the taxable year, and
(C) No new amounts are borrowed on the debt during the taxable year,
the average balance of the debt may be determined by adding the principal balance as of the first day of the taxable year that the debt is secured by the qualified residence and the principal balance as of the last day of the taxable year that the debt is secured by the qualified residence and dividing the sum by 2. If the debt is secured by a qualified residence for less than the entire period during the taxable year that the residence is a qualified residence, the average balance may be determined by multiplying the average balance determined under the preceding sentence by a fraction, the numerator of which is the number of days during the taxable year that the debt is secured by the qualified residence and the denominator of which is the number of days during the taxable year that the residence is a qualified residence. For purposes of this paragraph (h)(5)(i), the determination of whether payments are level shall disregard the fact that the amount of the payments may be adjusted from time to time to take into account changes in the applicable interest rate.
(ii) Example. C borrows $10,000 in 1988, securing the debt with a second mortgage on a principal residence. The terms of the loan require C to make equal monthly payments of principal and interest so as to amortize the entire loan balance over 20 years. The balance of the debt is $9,652 on January 1, 1990, and is $9,450 on December 31, 1990. The average balance of the debt during 1990 may be computed as follows:
(6) Highest principal balance. The average balance of a debt may be determined by taking the highest principal balance of the debt during the taxable year.
(7) Other methods provided by the Commissioner. The average balance may be determined using any other method provided by the Commissioner by form, publication, revenue ruling, or revenue procedure. Such methods may include methods similar to (but with restrictions different from) those provided in paragraph (h) of this section.
(8) Anti-abuse rule. If, as a result of the determination of the average balance of a debt using any of the methods specified in paragraphs (h) (4), (5), or (6) of this section, there is a significant overstatement of the amount of qualified residence interest and a principal purpose of the pattern of payments and borrowing on the debt is to cause the amount of such qualified residence interest to be overstated, the district director may redetermine the average balance using the method specified under paragraph (h)(3) of this section.
(i) [Reserved]
(j) Determination of interest paid or accrued during the taxable year—(1) In general. For purposes of determining the amount of qualified residence interest with respect to a secured debt, the amount of interest paid or accrued during the taxable year includes only interest paid or accrued while the debt is secured by a qualified residence.
(2) Special rules for cash-basis taxpayers—(i) Points deductible in year paid under section 461(g)(2). If points described in section 461(g)(2) (certain points paid in respect of debt incurred in connection with the purchase or improvement of a principal residence) are paid with respect to a debt, the amount of such points is qualified residence interest.
(ii) Points and other prepaid interest described in section 461(g)(1). The amount of points or other prepaid interest charged to capital account under section 461(g)(1) (prepaid interest) that is qualified residence interest shall be determined under the rules of paragraphs (c) through (e) of this section in the same manner as any other interest paid with respect to the debt in the taxable year to which such payments are allocable under section 461(g)(1).
(3) Examples.
(k) Determination of adjusted purchase price and fair market value—(1) Adjusted purchase price—(i) In general. For purposes of this section, the adjusted purchase price of a qualified residence is equal to the taxpayer's basis in the residence as initially determined under section 1012 or other applicable sections of the Internal Revenue Code, increased by the cost of any improvements to the residence that have been added to the taxpayer's basis in the residence under section 1016(a)(1). Any other adjustments to basis, including those required under section 1033(b) (involuntary conversions), and 1034(e) (rollover of gain or sale of principal residence) are disregarded in determining the taxpayer's adjusted purchase price. If, for example, a taxpayer's second residence is rented for a portion of the year and its basis is reduced by depreciation allowed in connection with the rental use of the property, the amount of the taxpayer's adjusted purchase price in the residence is not reduced. See paragraph (m) of this section for a rule that treats the sum of the grandfathered amounts of all secured debts as the adjusted purchase price of the residence.
(ii) Adjusted purchase price of a qualified residence acquired incident to divorce. [Reserved]
(iii) Examples.
(2) Fair market value—(i) In general. For purposes of this section, the fair market value of a qualified residence on any date is the fair market value of the taxpayer's interest in the residence on such date. In addition, the fair market value determined under this paragraph (k)(2)(i) shall be determined by taking into account the cost of improvements to the residence reasonably expected to be made with the proceeds of the debt.
(ii) Example. In 1988, the adjusted purchase price of P's second residence is $65,000 and the fair market value of the residence is $70,000. At that time, P incurs an additional debt of $10,000, the proceeds of which P reasonably expects to use to add two bedrooms to the residence. Because the fair market value is determined by taking into account the cost of improvements to the residence that are reasonably expected to be made with the proceeds of the debt, the fair market value of the residence with respect to the debt incurred in 1988 is $80,000 ($70,000 + $10,000).
(3) Allocation of adjusted purchase price and fair market value. If a property includes both a qualified residence and other property, the adjusted purchase price and the fair market value of such property must be allocated between the qualified residence and the other property. See paragraph (p)(4) of this section for rules governing such an allocation.
(l) [Reserved]
(m) Grandfathered amount—(1) Substitution for adjusted purchase price. If, for the taxable year, the sum of the grandfathered amounts, if any, of all secured debts exceeds the adjusted purchase price of the qualified residence, such sum may be treated as the adjusted purchase price of the residence under paragraphs (c), (d) and (e) of this section.
(2) Determination of grandfathered amount—(i) In general. For any taxable year, the grandfathered amount of any secured debt that was incurred on or before August 16, 1986, and was secured by the residence continuously from August 16, 1986, through the end of the taxable year, is the average balance of the debt for the taxable year. A secured debt that was not incurred and secured on or before August 16, 1986, has no grandfathered amount.
(ii) Special rule for lines of credit and certain other debt. If, with respect to a debt described in paragraph (m)(2)(i) of this section, a taxpayer has borrowed any additional amounts after August 16, 1986, the grandfathered amount of such debt is equal to the lesser of—
(A) The average balance of the debt for the taxable year, or
(B) The principal balance of the debt as of August 16, 1986, reduced (but not below zero) by all principal payments after August 16, 1986, and before the first day of the current taxable year.
For purposes of this paragraph (m)(2)(ii), a taxpayer shall not be considered to have borrowed any additional amount with respect to a debt merely because accrued interest is added to the principal balance of the debt, so long as such accrued interest is paid by the taxpayer no less often than quarterly.
(iii) Fair market value limitation. The grandfathered amount of any debt for any taxable year may not exceed the fair market value of the residence on August 16, 1986, reduced by the principal balance on that day of all previously secured debt.
(iv) Examples.
(3) Refinancing of grandfathered debt—(i) In general. A debt incurred and secured on or before August 16, 1986, is refinanced if some or all of the outstanding balance of such a debt (the “original debt”) is repaid out of the proceeds of a second debt secured by the same qualified residence (the “replacement debt”). In the case of a refinancing, the replacement debt is treated as a debt incurred and secured on or before August 16, 1986, and the grandfathered amount of such debt is the amount (but not less than zero) determined pursuant to paragraph (m)(3)(ii) of this section.
(ii) Determination of grandfathered amount—(A) Exact refinancing. If—
(1) The entire proceeds of a replacement debt are used to refinance one or more original debts, and
(2) The taxpayer has not borrowed any additional amounts after August 16, 1986, with respect to the original debt or debts,
the grandfathered amount of the replacement debt is the average balance of the replacement debt. For purposes of the preceding sentence, the fact that proceeds of a replacement debt are used to pay costs of obtaining the replacement debt (including points or other closing costs) shall be disregarded in determining whether the entire proceeds of the replacement debt have been used to refinance one or more original debts.
(B) Refinancing other than exact refinancings—(1) Year of refinancing. In the taxable year in which an original debt is refinanced, the grandfathered amount of the original and replacement debts is equal to the lesser of—
(i) The sum of the average balances of the original debt and the replacement debt, and
(ii) The principal balance of the original debt as of August 16, 1986, reduced by all principal payments on the original debt after August 16, 1986, and before the first day of the current taxable year.
(2) In subsequent years. In any taxable year after the taxable year in which an original debt is refinanced, the grandfathered amount of the replacement debt is equal to the least of—
(i) The average balance of the replacement debt for the taxable year,
(ii) The amount of the replacement debt used to repay the principal balance of the original debt, reduced by all principal payments on the replacement debt after the date of the refinancing and before the first day of the current taxable year, or
(iii) The principal balance of the original debt on August 16, 1986, reduced by all principal payments on the original debt after August 16, 1986, and before the date of the refinancing, and further reduced by all principal payments on the replacement debt after the date of the refinancing and before the first day of the current taxable year.
(C) Example. (i) Facts. On August 16, 1986, T has a single debt secured by a principal residence with a balance of $150,000. On July 1, 1988, T refinances the debt, which still has a principal balance of $150,000, with a new secured debt. The principal balance of the replacement debt throughout 1988 and 1989 is $150,000. The adjusted purchase price of the residence is $100,000 throughout 1987, 1988 and 1989. The average balance of the original debt was $150,000 in 1987 and $75,000 in 1988. The average balance of the replacement debt is $75,000 in 1988 and $150,000 in 1989.
(ii) Grandfathered amount in 1987. The original debt was incurred and secured on or before August 16, 1986 and T has not borrowed any additional amounts with respect to the debt. Therefore, its grandfathered amount in 1987 is its average balance ($150,000). This amount is treated as the adjusted purchase price for 1987 and all of the interest paid on the debt is qualified residence interest.
(iii) Grandfathered amount in 1988. Because the replacement debt was used to refinance a debt incurred and secured on or before August 16, 1986, the replacement debt is treated as a grandfathered debt. Because all of the proceeds of the replacement debt were used in the refinancing and because no amounts have been borrowed after August 16, 1986, on the original debt, the grandfathered amount for the original debt is its average balance ($75,000) and the grandfathered amount for the replacement debt is its average balance ($75,000). Since the sum of the grandfathered amounts ($150,000) exceeds the adjusted purchase price of the residence, the sum of the grandfathered amounts may be substituted for the adjusted purchase price for 1988 and all of the interest paid on the debt is qualified residence interest.
(iv) Grandfathered amount in 1989. The grandfathered amount for the placement debt is its average balance ($150,000). This amount is treated as the adjusted purchase price for 1989 and all of the interest paid on the mortgage is qualified residence interest.
(4) Limitation on term of grandfathered debt—(i) In general. An original debt or replacement debt shall not have any grandfathered amount in any taxable year that begins after the date, as determined on August 16, 1986, that the original debt was required to be repaid in full (the “maturity date”). If a replacement debt is used to refinance more than one original debt, the maturity date is determined by reference to the original debt that, as of August 16, 1986, had the latest maturity date.
(ii) Special rule for nonamortizing debt. If an original debt was actually incurred and secured on or before August 16, 1986, and if as of such date the terms of such debt did not require the amortization of its principal over its original term, the maturity date of the replacement debt is the earlier of the maturity date of the replacement debt or the date 30 years after the date the original debt is first refinanced.
(iii) Example. C incurs a debt on May 10, 1986, the final payment of which is due May 1, 2006. C incurs a second debt on August 11, 1990, with a term of 20 years and uses the proceeds of the second debt to refinance the first debt. Because, under paragraph (m)(4)(i) of this section, a replacement debt will not have any grandfathered amount in any taxable year that begins after the maturity date of the original debt (May 1, 2006), the second debt has no grandfathered amount in any taxable year after 2006.
(n) Qualified indebtedness (secured debt used for medical and educational purposes)—(1) In general—(i) Treatment of qualified indebtedness. The amount of any qualified indebtedness resulting from a secured debt may be added to the adjusted purchase price under paragraph (e)(2)(i)(B) of this section to determine the applicable debt limit for that secured debt and any other debt subsequently secured by the qualified residence.
(ii) Determination of amount of qualified indebtedness. If, as of the end of the taxable year (or the last day in the taxable year that the debt is secured), at least 90 percent of the proceeds of a secured debt are used (within the meaning of paragraph (n)(2) of this section) to pay for qualified medical and educational expenses (within the meaning of paragraphs (n)(3) and (n)(4) of this section), the amount of qualified indebtedness resulting from that debt for the taxable year is equal to the average balance of such debt for the taxable year.
(iii) Determination of amount of qualified indebtedness for mixed-use debt. If, as of the end of the taxable year (or the last day in the taxable year that the debt is secured), more than ten percent of the proceeds of a secured debt are used to pay for expenses other than qualified medical and educational expenses, the amount of qualified indebtedness resulting from that debt for the taxable year shall equal the lesser of—
(A) The average balance of the debt, or
(B) The amount of the proceeds of the debt used to pay for qualified medical and educational expenses through the end of the taxable year, reduced by any principal payments on the debt before the first day of the current taxable year.
(iv) Example. (i) C incurs a $10,000 debt on April 20, 1987, which is secured on that date by C's principal residence. C immediately uses (within the meaning of paragraph (n)(2) of this section) $4,000 of the proceeds of the debt to pay for a qualified medical expense. C makes no principal payments on the debt during 1987. During 1988 and 1989, C makes principal payments of $1,000 per year. The average balance of the debt during 1988 is $9,500 and the average balance during 1989 is $8,500.
(ii) Under paragraph (n)(1)(iii) of this section, C determines the amount of qualified indebtedness for 1988 as follows:
The amount of qualified indebtedness for 1988 is, therefore, $4,000 (lesser of $9,500 average balance or $4,000 net qualified expenses). This amount may be added to the adjusted purchase price of C's principal residence under paragraph (e)(2)(i)(B) of this section for purposes of computing the applicable debt limit for this debt and any other debt subsequently secured by the principal residence.
(iii) C determines the amount of qualified indebtedness for 1989 as follows:
The amount of qualified indebtedness for 1989 is, therefore, $3,000 (lesser of $8,500 average balance or $3,000 net qualified expenses).
(v) Prevention of double counting in year of refinancing—(A) In general. A debt used to pay for qualified medical or educational expenses is refinanced if some or all of the outstanding balance of the debt (the “original debt”) is repaid out of the proceeds of a second debt (the “replacement debt”). If, in the year of a refinancing, the combined qualified indebtedness of the original debt and the replacement debt exceeds the combined qualified expenses of such debts, the amount of qualified indebtedness for each such debt shall be determined by multiplying the amount of qualified indebtedness for each such debt by a fraction, the numerator of which is the combined qualified expenses and the denominator of which is the combined qualified indebtedness.
(B) Definitions. For purposes of paragraph (n)(1)(v)(A) of this section—
(1) The term “combined qualified indebtedness” means the sum of the qualified indebtedness (determined without regard to paragraph (n)(1)(v) of this section) for the original debt and the replacement debt.
(2) The term “combined qualified expenses” means the amount of the proceeds of the original debt used to pay for qualified medical and educational expenses through the end of the current taxable year, reduced by any principal payments on the debt before the first day of the current taxable year, and increased by the amount, if any, of the proceeds of the replacement debt used to pay such expenses through the end of the current taxable year other than as part of the refinancing.
(C) Example. (i) On August 11, 1987, C incurs a $8,000 debt secured by a principal residence. C uses (within the meaning of paragraph (n)(2)(i) of this section) $5,000 of the proceeds of the debt to pay for qualified educational expenses. C makes no principal payments on the debt. On July 1, 1988, C incurs a new debt in the amount of $8,000 secured by C's principal residence and uses all of the proceeds of the new debt to repay the original debt. Under paragraph (n)(2)(ii) of this section $5,000 of the new debt is treated as being used to pay for qualified educational expenses. C makes no principal payments (other than the refinancing) during 1987 or 1988 on either debt and pays all accrued interest monthly. The average balance of each debt in 1988 is $4,000.
(ii) Under paragraph (n)(1)(iii) of this section, the amount of qualified indebtedness for 1988 with respect to the original debt is $4,000 (the lesser of its average balance ($4,000) and the amount of the debt used to pay for qualified medical and educational expenses ($5,000)). Similarly, the amount of qualified indebtedness for 1988 with respect to the replacement debt is also $4,000. Both debts, however, are subject in 1988 to the limitation in paragraph (n)(1)(v)(A) of this section. The combined qualified indebtedness, determined without regard to the limitation, is $8,000 ($4,000 of qualified indebtedness from each debt). The combined qualified expenses are $5,000 ($5,000 from the original debt and $0 from the replacement debt). The amount of qualified indebtedness from each debt must, therefore, be reduced by a fraction, the numerator of which is $5,000 (the combined qualified expenses) and the denominator of which is $8,000 (the combined qualified indebtedness). After application of the limitation, the amount of qualified indebtedness for the original debt is $2,500 ($4,000 × ×
5/8). Similarly, the amount of qualified indebtedness for the replacement debt is $2,500. Note that the total qualified indebtedness for both the original and the replacement debt is $5,000 ($2,500 + $2,500). Therefore, C is entitled to the same amount of qualified indebtedness as C would have been entitled to if C had not refinanced the debt.
(vi) Special rule for principal payments in excess of qualified expenses. For purposes of paragraph (n)(1)(iii)(B), (n)(1)(v)(B)(2) and (n)(2)(ii) of this section, a principal payment is taken into account only to the extent that the payment, when added to all prior payments, does not exceed the amount used on or before the date of the payment to pay for qualified medical and educational expenses.
(2) Debt used to pay for qualified medical or educational expenses—(i) In general. For purposes of this section, the proceeds of a debt are used to pay for qualified medical or educational expenses to the extent that—
(A) The taxpayer pays qualified medical or educational expenses within 90 days before or after the date that amounts are actually borrowed with respect to the debt, the proceeds of the debt are not directly allocable to another expense under § 1.163-8T(c)(3) (allocation of debt; proceeds not disbursed to borrower) and the proceeds of any other debt are not allocable to the medical or educational expenses under § 1.163-8T(c)(3), or
(B) The proceeds of the debt are otherwise allocated to such expenditures under § 1.163-8T.
(ii) Special rule for refinancings. For purposes of this section, the proceeds of a debt are used to pay for qualified medical and educational expenses to the extent that the proceeds of the debt are allocated under § 1.163-8T to the repayment of another debt (the “original debt”), but only to the extent of the amount of the original debt used to pay for qualified medical and educational expenses, reduced by any principal payments on such debt up to the time of the refinancing.
(iii) Other special rules. The following special rules apply for purposes of this section.
(A) Proceeds of a debt are used to pay for qualified medical or educational expenses as of the later of the taxable year in which such proceeds are borrowed or the taxable year in which such expenses are paid.
(B) The amount of debt which may be treated as being used to pay for qualified medical or educational expenses may not exceed the amount of such expenses.
(C) Proceeds of a debt may not be treated as being used to pay for qualified medical or educational expenses to the extent that:
(1) The proceeds have been repaid as of the time the expense is paid;
(2) The proceeds are actually borrowed before August 17, 1986; or
(3) The medical or educational expenses are paid before August 17, 1986.
(iv) Examples—
(3) Qualified medical expenses. Qualified medical expenses are amounts that are paid for medical care (within the meaning of section 213(d)(1) (A) and (B)) for the taxpayer, the taxpayer's spouse, or a dependent of the taxpayer (within the meaning of section 152), and that are not compensated for by insurance or otherwise.
(4) Qualified educational expenses. Qualified educational expenses are amounts that are paid for tuition, fees, books, supplies and equipment required for enrollment, attendance or courses of instruction at an educational organization described in section 170(b) (1)(A)(ii) and for any reasonable living expenses while away from home while in attendance at such an institution, for the taxpayer, the taxpayer's spouse or a dependent of the taxpayer (within the meaning of section 152) and that are not reimbursed by scholarship or otherwise.
(o) Secured debt—(1) In general. For purposes of this section, the term “secured debt” means a debt that is on the security of any instrument (such as a mortgage, deed of trust, or land contract)—
(i) That makes the interest of the debtor in the qualified residence specific security for the payment of the debt,
(ii) Under which, in the event of default, the residence could be subjected to the satisfaction of the debt with the same priority as a mortgage or deed of trust in the jurisdiction in which the property is situated, and
(iii) That is recorded, where permitted, or is otherwise perfected in accordance with applicable State law.
A debt will not be considered to be secured by a qualified residence if it is secured solely by virtue of a lien upon the general assets of the taxpayer or by a security interest, such as a mechanic's lien or judgment lien, that attaches to the property without the consent of the debtor.
(2) Special rule for debt in certain States. Debt will not fail to be treated as secured solely because, under an applicable State or local homestead law or other debtor protection law in effect on August 16, 1986, the security interest is ineffective or the enforceability of the security interest is restricted.
(3) Times at which debt is treated as secured. For purposes of this section, a debt is treated as secured as of the date on which each of the requirements of paragraph (o)(1) of this section are satisfied, regardless of when amounts are actually borrowed with respect to the debt. For purposes of this paragraph (o)(3), if the instrument is recorded within a commercially reasonable time after the security interest is granted, the instrument will be treated as recorded on the date that the security interest was granted.
(4) Partially secured debt—(i) In general. If the security interest is limited to a prescribed maximum amount or portion of the residence, and the average balance of the debt exceeds such amount or the value of such portion, such excess shall not be treated as secured debt for purposes of this section.
(ii) Example. T borrows $80,000 on January 1, 1991. T secures the debt with a principal residence. The security in the residence for the debt, however, is limited to $20,000. T pays $8,000 in interest on the debt in 1991 and the average balance of the debt in that year is $80,000. Because the average balance of the debt exceeds the maximum amount of the security interest, such excess is not treated as secured debt. Therefore, for purposes of applying the limitation on qualified residence interest, the average balance of the secured debt is $20,000 (the maximum amount of the security interest) and the interest paid or accrued on the secured debt is $2,000 (the total interest paid on the debt multiplied by the ratio of the average balance of the secured debt ($20,000) and the average balance of the total debt ($80,000)).
(5) Election to treat debt as not secured by a qualified residence—(i) In general. For purposes of this section, a taxpayer may elect to treat any debt that is secured by a qualified residence as not secured by the qualified residence. An election made under this paragraph shall be effective for the taxable year for which the election is made and for all subsequent taxable years unless revoked with the consent of the Commissioner.
(ii) Example. T owns a principal residence with a fair market value of $75,000 and an adjusted purchase price of $40,000. In 1988, debt A, the proceeds of which were used to purchase the residence, has an average balance of $15,000. The proceeds of debt B, which is secured by a second mortgage on the property, are allocable to T's trade or business under § 1.163-8T and has an average balance of $25,000. In 1988, T incurs debt C, which is also secured by T's principal residence and which has an average balance in 1988 of $5,000. In the absence of an election to treat debt B as unsecured, the applicable debt limit for debt C in 1988 under paragraph (e) of this section would be zero dollars ($40,000−$15,000−$25,000) and none of the interest paid on debt C would be qualified residence interest. If, however, T makes or has previously made an election pursuant to paragraph (o)(5)(i) of this section to treat debt B as not secured by the residence, the applicable debt limit for debt C would be $25,000 ($40,000−$15,000), and all of the interest paid on debt C during the taxable year would be qualified residence interest. Since the proceeds of debt B are allocable to T's trade or business under § 1.163-8T, interest on debt B may be deductible under other sections of the Internal Revenue Code.
(iii) Allocation of debt secured by two qualified residences. [Reserved]
(p) Definition of qualified residence—(1) In general. The term “qualified residence” means the taxpayer's principal residence (as defined in paragraph (p)(2) of this section), or the taxpayer's second residence (as defined in paragraph (p)(3) of this section).
(2) Principal residence. The term “principal residence” means the taxpayer's principal residence within the meaning of section 1034. For purposes of this section, a taxpayer cannot have more than one principal residence at any one time.
(3) Second residence—(i) In general. The term “second residence” means—
(A) A residence within the meaning of paragraph (p)(3)(ii) of this section,
(B) That the taxpayer uses as a residence within the meaning of paragraph (p)(3)(iii) of this section, and
(C) That the taxpayer elects to treat as a second residence pursuant to paragraph (p)(3)(iv) of this section.
A taxpayer cannot have more than one second residence at any time.
(ii) Definition of residence. Whether property is a residence shall be determined based on all the facts and circumstances, including the good faith of the taxpayer. A residence generally includes a house, condominium, mobile home, boat, or house trailer, that contains sleeping space and toilet and cooking facilities. A residence does not include personal property, such as furniture or a television, that, in accordance with the applicable local law, is not a fixture.
(iii) Use as a residence. If a residence is rented at any time during the taxable year, it is considered to be used as a residence only if the taxpayer uses it during the taxable year as a residence within the meaning of section 280A(d). If a residence is not rented at any time during the taxable year, it shall be considered to be used as a residence. For purposes of the preceding sentence, a residence will be deemed to be rented during any period that the taxpayer holds the residence out for rental or resale or repairs or renovates the residence with the intention of holding it out for rental or resale.
(iv) Election of second residence. A taxpayer may elect a different residence (other than the taxpayer's principal residence) to be the taxpayer's second residence for each taxable year. A taxpayer may not elect different residences as second residences at different times of the same taxable year except as provided below—
(A) If the taxpayer acquires a new residence during the taxable year, the taxpayer may elect the new residence as a taxpayer's second residence as of the date acquired;
(B) If property that was the taxpayer's principal residence during the taxable year ceases to qualify as the taxpayer's principal residence, the taxpayer may elect that property as the taxpayer's second residence as of the date that the property ceases to be the taxpayer's principal residence; or
(C) If property that was the taxpayer's second residence is sold during the taxable year or becomes the taxpayer's principal residence, the taxpayer may elect a new second residence as of such day.
(4) Allocations between residence and other property—(i) In general. For purposes of this section, the adjusted purchase price and fair market value of property must be allocated between the portion of the property that is a qualified residence and the portion that is not a qualified residence. Neither the average balance of the secured debt nor the interest paid or accrued on secured debt is so allocated. Property that is not used for residential purposes does not qualify as a residence. For example, if a portion of the property is used as an office in the taxpayer's trade or business, that portion of the property does not qualify as a residence.
(ii) Special rule for rental of residence. If a taxpayer rents a portion of his or her principal or second residence to another person (a “tenant”), such portion may be treated as used by the taxpayer for residential purposes if, but only if—
(A) Such rented portion is used by the tenant primarily for residential purposes,
(B) The rented portion is not a self-contained residential unit containing separate sleeping space and toilet and cooking facilities, and
(C) The total number of tenants renting (directly or by sublease) the same or different portions of the residence at any time during the taxable year does not exceed two. For this purpose, if two persons (and the dependents, as defined by section 152, of either of them) share the same sleeping quarters, they shall be treated as a single tenant.
(iii) Examples.
(5) Residence under construction—(i) In general. A taxpayer may treat a residence under construction as a qualified residence for a period of up to 24 months, but only if the residence becomes a qualified residence, without regard to this paragraph (p)(5)(i), as of the time that the residence is ready for occupancy.
(ii) Example. X owns a residential lot suitable for the construction of a vacation home. On April 20, 1987, X obtains a mortgage secured by the lot and any property to be constructed on the lot. On August 9, 1987, X begins construction of a residence on the lot. The residence is ready for occupancy on November 9, 1989. The residence is used as a residence within the meaning of paragraph (p)(3)(iii) of this section during 1989 and X elects to treat the residence as his second residence for the period November 9, 1989, through December 31, 1989. Since the residence under construction is a qualified residence as of the first day that the residence is ready for occupancy (November 9, 1987), X may treat the residence as his second residence under paragraph (p)(5)(i) of this section for up to 24 months of the period during which the residence is under construction, commencing on or after the date that construction is begun (August 9, 1987). If X treats the residence under construction as X's second residence beginning on August 9, 1987, the residence under construction would cease to qualify as a qualified residence under paragraph (p)(5)(i) on August 8, 1989. The residence's status as a qualified residence for future periods would be determined without regard to paragraph (p)(5)(i) of this section.
(6) Special rule for time-sharing arrangements. Property that is otherwise a qualified residence will not fail to qualify as such solely because the taxpayer's interest in or right to use the property is restricted by an arrangement whereby two or more persons with interests in the property agree to exercise control over the property for different periods during the taxable year. For purposes of determining the use of a residence under paragraph (p)(3)(iii) of this section, a taxpayer will not be considered to have used or rented a residence during any period that the taxpayer does not have the right to use the property or to receive any benefits from the rental of the property.
(q) Special rules for tenant-stockholders in cooperative housing corporations—(1) In general. For purposes of this section, a residence includes stock in a cooperative housing corporation owned by a tenant-stockholder if the house or apartment which the tenant-stockholder is entitled to occupy by virtue of owning such stock is a residence within the meaning of paragraph (p)(3)(ii) of this section.
(2) Special rule where stock may not be used to secure debt. For purposes of this section, if stock described in paragraph (q)(1) of this section may not be used to secure debt because of restrictions under local or State law or because of restrictions in the cooperative agreement (other than restrictions the principal purpose of which is to permit the tenant-stockholder to treat unsecured debt as secured debt under this paragraph (q)(2)), debt may be treated as secured by such stock to the extent that the proceeds of the debt are allocated to the purchase of the stock under the rules of § 1.163-8T. For purposes of this paragraph (q)(2), proceeds of debt incurred prior to January 1, 1987, may be treated as allocated to the purchase of such stock to the extent that the tenant-stockholder has properly and consistently deducted interest expense on such debt as home mortgage interest attributable to such stock on Schedule A of Form 1040 in determining his taxable income for taxable years beginning before January 1, 1987. For purposes of this paragraph (q)(2), amended returns filed after December 22, 1987, are disregarded.
(3) Treatment of interest expense of the cooperative described in section 216(a)(2). For purposes of section 163(h) and § 1.163-9T (disallowance of deduction for personal interest) and section 163(d) (limitation on investment interest), any amount allowable as a deduction to a tenant-stockholder under section 216(a)(2) shall be treated as interest paid or accrued by the tenant-stockholder. If a tenant-stockholder's stock in a cooperative housing corporation is a qualified residence of the tenant-shareholder, any amount allowable as a deduction to the tenant-stockholder under section 216(a)(2) is qualified residence interest.
(4) Special rule to prevent tax avoidance. If the amount treated as qualified residence interest under this section exceeds the amount which would be so treated if the tenant-stockholder were treated as directly owning his proportionate share of the assets and liabilities of the cooperative and one of the principal purposes of the cooperative arrangement is to permit the tenant-stockholder to increase the amount of qualified residence interest, the district director may determine that such excess is not qualified residence interest.
(5) Other definitions. For purposes of this section, the terms “tenant-stockholder,” “cooperative housing corporation” and “proportionate share” shall have the meaning given by section 216 and the regulations thereunder.
(r) Effective date. The provisions of this section are effective for taxable years beginning after December 31, 1986.
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Treas. Reg. §1.163-10T(a)Table of contents.
Table of contents.
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Treas. Reg. §1.163-10T(b)Treatment of qualified residence interest.
Treatment of qualified residence interest. Except as provided below, qualified residence interest is deductible under section 163(a). Qualified residence interest is not subject to limitation or otherwise taken into account under section 163(d) (limitation on investment interest), section 163(h)(1) (disallowance of deduction for personal interest), section 263A (capitalization and inclusion in inventory costs of certain expenses) or section 469 (limitations on losses from passive activities). Qualified residence interest is subject to the limitation imposed by section 263(g) (certain interest in the case of straddles), section 264(a) (2) and (4) (interest paid in connection with certain insurance), section 265(a)(2) (interest relating to tax-exempt income), section 266 (carrying charges), section 267(a)(2) (interest with respect to transactions between related taxpayers) section 465 (deductions limited to amount at risk), section 1277 (deferral of interest deduction allocable to accrued market discount), and section 1282 (deferral of interest deduction allocable to accrued discount).
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Treas. Reg. §1.163-10T(c)Determination of qualified residence interest when secured debt does not exceed adjusted purchase price—(1) In general.
Determination of qualified residence interest when secured debt does not exceed adjusted purchase price—(1) In general. If the sum of the average balances for the taxable year of all secured debts on a qualified residence does not exceed the adjusted purchase price (determined as of the end of the taxable year) of the qualified residence, all of the interest paid or accrued during the taxable year with respect to the secured debts is qualified residence interest. If the sum of the average balances for the taxable year of all secured debts exceeds the adjusted purchase price of the qualified residences (determined as of the end of the taxable year), the taxpayer must use either the simplified method (see paragraph (d) of this section) or the exact method (see paragraph (e) of this section) to determine the amount of interest that is qualified residence interest.
(2) Examples.
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Treas. Reg. §1.163-10T(d)Determination of qualified residence interest when secured debt exceeds adjusted purchase price—Simplified method—(1) In general.
Determination of qualified residence interest when secured debt exceeds adjusted purchase price—Simplified method—(1) In general. Under the simplified method, the amount of qualified residence interest for the taxable year is equal to the total interest paid or accrued during the taxable year with respect to all secured debts multiplied by a fraction (not in excess of one), the numerator of which is the adjusted purchase price (determined as of the end of the taxable year) of the qualified residence and the denominator of which is the sum of the average balances of all secured debts.
(2) Treatment of interest paid or accrued on secured debt that is not qualified residence interest. Under the simplified method, the excess of the total interest paid or accrued during the taxable year with respect to all secured debts over the amount of qualified residence interest is personal interest.
(3) Example.
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Treas. Reg. §1.163-10T(e)Determination of qualified residence interest when secured debt exceeds adjusted purchase price—Exact method—(1) In general.
Determination of qualified residence interest when secured debt exceeds adjusted purchase price—Exact method—(1) In general. Under the exact method, the amount of qualified residence interest for the taxable year is determined on a debt-by-debt basis by computing the applicable debt limit for each secured debt and comparing each such applicable debt limit to the average balance of the corresponding debt. If, for the taxable year, the average balance of a secured debt does not exceed the applicable debt limit for that debt, all of the interest paid or accrued during the taxable year with respect to the debt is qualified residence interest. If the average balance of the secured debt exceeds the applicable debt limit for that debt, the amount of qualified residence interest with respect to the debt is determined by multiplying the interest paid or accrued with respect to the debt by a fraction, the numerator of which is the applicable debt limit for that debt and the denominator of which is the average balance of the debt.
(2) Determination of applicable debt limit. For each secured debt, the applicable debt limit for the taxable year is equal to
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Treas. Reg. §1.163-10T(f)Special rules—(1) Special rules for personal property—(i) In general.
Special rules—(1) Special rules for personal property—(i) In general. If a qualified residence is personal property under State law (e.g., a boat or motorized vehicle)—
(A) For purposes of paragraphs (c)(1) and (d)(1) of this section, if the fair market value of the residence as of the date that any secured debt (outstanding during the taxable year) is first secured by the residence is less than the adjusted purchase price as of the end of the taxable year, the lowest such fair market value shall be substituted for the adjusted purchase price.
(B) For purposes of paragraphs (e)(2)(i)(A) and (f)(1)(i)(A) of this section, the fair market value of the residence as of the date the debt is first secured by the residence shall not exceed the fair market value as of any date on which the taxpayer borrows any additional amount with respect to the debt.
(ii) Example. D owns a recreational vehicle that is a qualified residence under paragraph (p)(4) of this section. The adjusted purchase price and fair market value of the recreational vehicle is $20,000 in 1989. In 1989, D establishes a line of credit secured by the recreational vehicle. As of June 1, 1992, the fair market value of the vehicle has decreased to $10,000. On that day, D borrows an additional amount on the debt by using the line of credit. Although under paragraphs (e)(2)(i) and (f)(1)(i)(A) of this section, fair market value is determined at the time the debt is first secured, under paragraph (f)(1)(i)(B) of this section, the fair market value is the lesser of that amount or the fair market value on the most recent date that D borrows any additional amount with respect to the line of credit. Therefore, the fair market value with respect to the debt is $10,000.
(2) Special rule for real property—(i) In general. For purposes of paragraph (e)(2)(i)(A) of this section, the fair market value of a qualified residence that is real property under State law is presumed irrebuttably to be not less than the adjusted purchase price of the residence as of the last day of the taxable year.
(ii) Example. (i) C purchases a residence on August 11, 1987, for $50,000, incurring a first mortgage. The residence is real property under State law. During 1987, C makes $10,000 in home improvements. Accordingly, the adjusted purchase price of the residence as of December 31, 1988, is $60,000. C incurs a second mortgage on May 19, 1988, as of which time the fair market value of the residence is $55,000.
(ii) For purposes of determining the applicable debt limit for each debt, the fair market value of the residence is generally determined as of the time the debt is first secured. Accordingly, the fair market value would be $50,000 and $55,000 with respect to the first and second mortgage, respectively. Under the special rule of paragraph (f)(2)(i) of this section, however, the fair market value with respect to both debts in 1988 is $60,000, the adjusted purchase price on December 31, 1988.
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Treas. Reg. §1.163-10T(g)Selection of method.
Selection of method. For any taxable year, a taxpayer may use the simplified method (described in paragraph (d) of this section) or the exact method (described in paragraph (e) of this section) by completing the appropriate portion of Form 8598. A taxpayer with two qualified residences may use the simplified method for one residence and the exact method for the other residence.
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Treas. Reg. §1.163-10T(h)Average balance—(1) Average balance defined.
Average balance—(1) Average balance defined. For purposes of this section, the term “average balance” means the amount determined under this paragraph (h). A taxpayer is not required to use the same method to determine the average balance of all secured debts during a taxable year or of any particular secured debt from one year to the next.
(2) Average balance reported by lender. If a lender that is subject to section 6050H (returns relating to mortgage interest received in trade or business from individuals) reports the average balance of a secured debt on Form 1098, the taxpayer may use the average balance so reported.
(3) Average balance computed on a daily basis—(i) In general. The average balance may be determined by—
(A) Adding the outstanding balance of a debt on each day during the taxable year that the debt is secured by a qualified residence, and
(B) Dividing the sum by the number of days during the taxable year that the residence is a qualified residence.
(ii) Example. Taxpayer A incurs a debt of $10,000 on September 1, 1989, securing the debt with A's principal residence. The residence is A's principal residence during the entire taxable year. A pays current interest on the debt monthly, but makes no principal payments. The debt is, therefore, outstanding for 122 days with a balance each day of $10,000. The residence is a qualified residence for 365 days. The average balance of the debt for 1989 is $3,342 (122 × $10,000/365).
(4) Average balance computed using the interest rate—(i) In general. If all accrued interest on a secured debt is paid at least monthly, the average balance of the secured debt may be determined by dividing the interest paid or accrued during the taxable year while the debt is secured by a qualified residence by the annual interest rate on the debt. If the interest rate on a debt varies during the taxable year, the lowest annual interest rate that applies to the debt during the taxable year must be used for purposes of this paragraph (h)(4). If the residence securing the debt is a qualified residence for less than the entire taxable year, the average balance of any secured debt may be determined by dividing the average balance determined under the preceding sentence by the percentage of the taxable year that the debt is secured by a qualified residence.
(ii) Points and prepaid interest. For purposes of paragraph (h)(4)(i) of this section, the amount of interest paid during the taxable year does not include any amount paid as points and includes prepaid interest only in the year accrued.
(iii) Examples.
(5) Average balance computed using average of beginning and ending balances—(i) In general. If—
(A) A debt requires level payments at fixed equal intervals (e.g., monthly, quarterly) no less often than semi-annually during the taxable year,
(B) The taxpayer prepays no more than one month's principal on the debt during the taxable year, and
(C) No new amounts are borrowed on the debt during the taxable year,
the average balance of the debt may be determined by adding the principal balance as of the first day of the taxable year that the debt is secured by the qualified residence and the principal balance as of the last day of the taxable year that the debt is secured by the qualified residence and dividing the sum by 2. If the debt is secured by a qualified residence for less than the entire period during the taxable year that the residence is a qualified residence, the average balance may be determined by multiplying the average balance determined under the preceding sentence by a fraction, the numerator of which is the number of days during the taxable year that the debt is secured by the qualified residence and the denominator of which is the number of days during the taxable year that the residence is a qualified residence. For purposes of this paragraph (h)(5)(i), the determination of whether payments are level shall disregard the fact that the amount of the payments may be adjusted from time to time to take into account changes in the applicable interest rate.
(ii) Example. C borrows $10,000 in 1988, securing the debt with a second mortgage on a principal residence. The terms of the loan require C to make equal monthly payments of principal and interest so as to amortize the entire loan balance over 20 years. The balance of the debt is $9,652 on January 1, 1990, and is $9,450 on December 31, 1990. The average balance of the debt during 1990 may be computed as follows:
(6) Highest principal balance. The average balance of a debt may be determined by taking the highest principal balance of the debt during the taxable year.
(7) Other methods provided by the Commissioner. The average balance may be determined using any other method provided by the Commissioner by form, publication, revenue ruling, or revenue procedure. Such methods may include methods similar to (but with restrictions different from) those provided in paragraph (h) of this section.
(8) Anti-abuse rule. If, as a result of the determination of the average balance of a debt using any of the methods specified in paragraphs (h) (4), (5), or (6) of this section, there is a significant overstatement of the amount of qualified residence interest and a principal purpose of the pattern of payments and borrowing on the debt is to cause the amount of such qualified residence interest to be overstated, the district director may redetermine the average balance using the method specified under paragraph (h)(3) of this section.
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Treas. Reg. §1.163-10T(i)§1.163-10T(i)
That makes the interest of the debtor in the qualified residence specific security for the payment of the debt,
(ii) Under which, in the event of default, the residence could be subjected to the satisfaction of the debt with the same priority as a mortgage or deed of trust in the jurisdiction in which the property is situated, and
(iii) That is recorded, where permitted, or is otherwise perfected in accordance with applicable State law.
A debt will not be considered to be secured by a qualified residence if it is secured solely by virtue of a lien upon the general assets of the taxpayer or by a security interest, such as a mechanic's lien or judgment lien, that attaches to the property without the consent of the debtor.
(2) Special rule for debt in certain States. Debt will not fail to be treated as secured solely because, under an applicable State or local homestead law or other debtor protection law in effect on August 16, 1986, the security interest is ineffective or the enforceability of the security interest is restricted.
(3) Times at which debt is treated as secured. For purposes of this section, a debt is treated as secured as of the date on which each of the requirements of paragraph (o)(1) of this section are satisfied, regardless of when amounts are actually borrowed with respect to the debt. For purposes of this paragraph (o)(3), if the instrument is recorded within a commercially reasonable time after the security interest is granted, the instrument will be treated as recorded on the date that the security interest was granted.
(4) Partially secured debt—(i) In general. If the security interest is limited to a prescribed maximum amount or portion of the residence, and the average balance of the debt exceeds such amount or the value of such portion, such excess shall not be treated as secured debt for purposes of this section.
(ii) Example. T borrows $80,000 on January 1, 1991. T secures the debt with a principal residence. The security in the residence for the debt, however, is limited to $20,000. T pays $8,000 in interest on the debt in 1991 and the average balance of the debt in that year is $80,000. Because the average balance of the debt exceeds the maximum amount of the security interest, such excess is not treated as secured debt. Therefore, for purposes of applying the limitation on qualified residence interest, the average balance of the secured debt is $20,000 (the maximum amount of the security interest) and the interest paid or accrued on the secured debt is $2,000 (the total interest paid on the debt multiplied by the ratio of the average balance of the secured debt ($20,000) and the average balance of the total debt ($80,000)).
(5) Election to treat debt as not secured by a qualified residence—(i) In general. For purposes of this section, a taxpayer may elect to treat any debt that is secured by a qualified residence as not secured by the qualified residence. An election made under this paragraph shall be effective for the taxable year for which the election is made and for all subsequent taxable years unless revoked with the consent of the Commissioner.
(ii) Example. T owns a principal residence with a fair market value of $75,000 and an adjusted purchase price of $40,000. In 1988, debt A, the proceeds of which were used to purchase the residence, has an average balance of $15,000. The proceeds of debt B, which is secured by a second mortgage on the property, are allocable to T's trade or business under § 1.163-8T and has an average balance of $25,000. In 1988, T incurs debt C, which is also secured by T's principal residence and which has an average balance in 1988 of $5,000. In the absence of an election to treat debt B as unsecured, the applicable debt limit for debt C in 1988 under paragraph (e) of this section would be zero dollars ($40,000−$15,000−$25,000) and none of the interest paid on debt C would be qualified residence interest. If, however, T makes or has previously made an election pursuant to paragraph (o)(5)(i) of this section to treat debt B as not secured by the residence, the applicable debt limit for debt C would be $25,000 ($40,000−$15,000), and all of the interest paid on debt C during the taxable year would be qualified residence interest. Since the proceeds of debt B are allocable to T's trade or business under § 1.163-8T, interest on debt B may be deductible under other sections of the Internal Revenue Code.
(iii) Allocation of debt secured by two qualified residences. [Reserved]
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Treas. Reg. §1.163-10T(j)Determination of interest paid or accrued during the taxable year—(1) In general.
Determination of interest paid or accrued during the taxable year—(1) In general. For purposes of determining the amount of qualified residence interest with respect to a secured debt, the amount of interest paid or accrued during the taxable year includes only interest paid or accrued while the debt is secured by a qualified residence.
(2) Special rules for cash-basis taxpayers—(i) Points deductible in year paid under section 461(g)(2). If points described in section 461(g)(2) (certain points paid in respect of debt incurred in connection with the purchase or improvement of a principal residence) are paid with respect to a debt, the amount of such points is qualified residence interest.
(ii) Points and other prepaid interest described in section 461(g)(1). The amount of points or other prepaid interest charged to capital account under section 461(g)(1) (prepaid interest) that is qualified residence interest shall be determined under the rules of paragraphs (c) through (e) of this section in the same manner as any other interest paid with respect to the debt in the taxable year to which such payments are allocable under section 461(g)(1).
(3) Examples.
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Treas. Reg. §1.163-10T(k)Determination of adjusted purchase price and fair market value—(1) Adjusted purchase price—(i) In general.
Determination of adjusted purchase price and fair market value—(1) Adjusted purchase price—(i) In general. For purposes of this section, the adjusted purchase price of a qualified residence is equal to the taxpayer's basis in the residence as initially determined under section 1012 or other applicable sections of the Internal Revenue Code, increased by the cost of any improvements to the residence that have been added to the taxpayer's basis in the residence under section 1016(a)(1). Any other adjustments to basis, including those required under section 1033(b) (involuntary conversions), and 1034(e) (rollover of gain or sale of principal residence) are disregarded in determining the taxpayer's adjusted purchase price. If, for example, a taxpayer's second residence is rented for a portion of the year and its basis is reduced by depreciation allowed in connection with the rental use of the property, the amount of the taxpayer's adjusted purchase price in the residence is not reduced. See paragraph (m) of this section for a rule that treats the sum of the grandfathered amounts of all secured debts as the adjusted purchase price of the residence.
(ii) Adjusted purchase price of a qualified residence acquired incident to divorce. [Reserved]
(iii) Examples.
(2) Fair market value—(i) In general. For purposes of this section, the fair market value of a qualified residence on any date is the fair market value of the taxpayer's interest in the residence on such date. In addition, the fair market value determined under this paragraph (k)(2)(i) shall be determined by taking into account the cost of improvements to the residence reasonably expected to be made with the proceeds of the debt.
(ii) Example. In 1988, the adjusted purchase price of P's second residence is $65,000 and the fair market value of the residence is $70,000. At that time, P incurs an additional debt of $10,000, the proceeds of which P reasonably expects to use to add two bedrooms to the residence. Because the fair market value is determined by taking into account the cost of improvements to the residence that are reasonably expected to be made with the proceeds of the debt, the fair market value of the residence with respect to the debt incurred in 1988 is $80,000 ($70,000 + $10,000).
(3) Allocation of adjusted purchase price and fair market value. If a property includes both a qualified residence and other property, the adjusted purchase price and the fair market value of such property must be allocated between the qualified residence and the other property. See paragraph (p)(4) of this section for rules governing such an allocation.
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Treas. Reg. §1.163-10T(l)§1.163-10T(l)
[Reserved]
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Treas. Reg. §1.163-10T(m)Grandfathered amount—(1) Substitution for adjusted purchase price.
Grandfathered amount—(1) Substitution for adjusted purchase price. If, for the taxable year, the sum of the grandfathered amounts, if any, of all secured debts exceeds the adjusted purchase price of the qualified residence, such sum may be treated as the adjusted purchase price of the residence under paragraphs (c), (d) and (e) of this section.
(2) Determination of grandfathered amount—(i) In general. For any taxable year, the grandfathered amount of any secured debt that was incurred on or before August 16, 1986, and was secured by the residence continuously from August 16, 1986, through the end of the taxable year, is the average balance of the debt for the taxable year. A secured debt that was not incurred and secured on or before August 16, 1986, has no grandfathered amount.
(ii) Special rule for lines of credit and certain other debt. If, with respect to a debt described in paragraph (m)(2)(i) of this section, a taxpayer has borrowed any additional amounts after August 16, 1986, the grandfathered amount of such debt is equal to the lesser of—
(A) The average balance of the debt for the taxable year, or
(B) The principal balance of the debt as of August 16, 1986, reduced (but not below zero) by all principal payments after August 16, 1986, and before the first day of the current taxable year.
For purposes of this paragraph (m)(2)(ii), a taxpayer shall not be considered to have borrowed any additional amount with respect to a debt merely because accrued interest is added to the principal balance of the debt, so long as such accrued interest is paid by the taxpayer no less often than quarterly.
(iii) Fair market value limitation. The grandfathered amount of any debt for any taxable year may not exceed the fair market value of the residence on August 16, 1986, reduced by the principal balance on that day of all previously secured debt.
(iv) Examples.
(3) Refinancing of grandfathered debt—(i) In general. A debt incurred and secured on or before August 16, 1986, is refinanced if some or all of the outstanding balance of such a debt (the “original debt”) is repaid out of the proceeds of a second debt secured by the same qualified residence (the “replacement debt”). In the case of a refinancing, the replacement debt is treated as a debt incurred and secured on or before August 16, 1986, and the grandfathered amount of such debt is the amount (but not less than zero) determined pursuant to paragraph (m)(3)(ii) of this section.
(ii) Determination of grandfathered amount—(A) Exact refinancing. If—
(1) The entire proceeds of a replacement debt are used to refinance one or more original debts, and
(2) The taxpayer has not borrowed any additional amounts after August 16, 1986, with respect to the original debt or debts,
the grandfathered amount of the replacement debt is the average balance of the replacement debt. For purposes of the preceding sentence, the fact that proceeds of a replacement debt are used to pay costs of obtaining the replacement debt (including points or other closing costs) shall be disregarded in determining whether the entire proceeds of the replacement debt have been used to refinance one or more original debts.
(B) Refinancing other than exact refinancings—(1) Year of refinancing. In the taxable year in which an original debt is refinanced, the grandfathered amount of the original and replacement debts is equal to the lesser of—
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Treas. Reg. §1.163-10T(n)Qualified indebtedness (secured debt used for medical and educational purposes)—(1) In general—(i) Treatment of qualified indebtedness.
Qualified indebtedness (secured debt used for medical and educational purposes)—(1) In general—(i) Treatment of qualified indebtedness. The amount of any qualified indebtedness resulting from a secured debt may be added to the adjusted purchase price under paragraph (e)(2)(i)(B) of this section to determine the applicable debt limit for that secured debt and any other debt subsequently secured by the qualified residence.
(ii) Determination of amount of qualified indebtedness. If, as of the end of the taxable year (or the last day in the taxable year that the debt is secured), at least 90 percent of the proceeds of a secured debt are used (within the meaning of paragraph (n)(2) of this section) to pay for qualified medical and educational expenses (within the meaning of paragraphs (n)(3) and (n)(4) of this section), the amount of qualified indebtedness resulting from that debt for the taxable year is equal to the average balance of such debt for the taxable year.
(iii) Determination of amount of qualified indebtedness for mixed-use debt. If, as of the end of the taxable year (or the last day in the taxable year that the debt is secured), more than ten percent of the proceeds of a secured debt are used to pay for expenses other than qualified medical and educational expenses, the amount of qualified indebtedness resulting from that debt for the taxable year shall equal the lesser of—
(A) The average balance of the debt, or
(B) The amount of the proceeds of the debt used to pay for qualified medical and educational expenses through the end of the taxable year, reduced by any principal payments on the debt before the first day of the current taxable year.
(iv) Example. (i) C incurs a $10,000 debt on April 20, 1987, which is secured on that date by C's principal residence. C immediately uses (within the meaning of paragraph (n)(2) of this section) $4,000 of the proceeds of the debt to pay for a qualified medical expense. C makes no principal payments on the debt during 1987. During 1988 and 1989, C makes principal payments of $1,000 per year. The average balance of the debt during 1988 is $9,500 and the average balance during 1989 is $8,500.
(ii) Under paragraph (n)(1)(iii) of this section, C determines the amount of qualified indebtedness for 1988 as follows:
The amount of qualified indebtedness for 1988 is, therefore, $4,000 (lesser of $9,500 average balance or $4,000 net qualified expenses). This amount may be added to the adjusted purchase price of C's principal residence under paragraph (e)(2)(i)(B) of this section for purposes of computing the applicable debt limit for this debt and any other debt subsequently secured by the principal residence.
(iii) C determines the amount of qualified indebtedness for 1989 as follows:
The amount of qualified indebtedness for 1989 is, therefore, $3,000 (lesser of $8,500 average balance or $3,000 net qualified expenses).
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Treas. Reg. §1.163-10T(o)Secured debt—(1) In general.
Secured debt—(1) In general. For purposes of this section, the term “secured debt” means a debt that is on the security of any instrument (such as a mortgage, deed of trust, or land contract)—
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Treas. Reg. §1.163-10T(p)Definition of qualified residence—(1) In general.
Definition of qualified residence—(1) In general. The term “qualified residence” means the taxpayer's principal residence (as defined in paragraph (p)(2) of this section), or the taxpayer's second residence (as defined in paragraph (p)(3) of this section).
(2) Principal residence. The term “principal residence” means the taxpayer's principal residence within the meaning of section 1034. For purposes of this section, a taxpayer cannot have more than one principal residence at any one time.
(3) Second residence—(i) In general. The term “second residence” means—
(A) A residence within the meaning of paragraph (p)(3)(ii) of this section,
(B) That the taxpayer uses as a residence within the meaning of paragraph (p)(3)(iii) of this section, and
(C) That the taxpayer elects to treat as a second residence pursuant to paragraph (p)(3)(iv) of this section.
A taxpayer cannot have more than one second residence at any time.
(ii) Definition of residence. Whether property is a residence shall be determined based on all the facts and circumstances, including the good faith of the taxpayer. A residence generally includes a house, condominium, mobile home, boat, or house trailer, that contains sleeping space and toilet and cooking facilities. A residence does not include personal property, such as furniture or a television, that, in accordance with the applicable local law, is not a fixture.
(iii) Use as a residence. If a residence is rented at any time during the taxable year, it is considered to be used as a residence only if the taxpayer uses it during the taxable year as a residence within the meaning of section 280A(d). If a residence is not rented at any time during the taxable year, it shall be considered to be used as a residence. For purposes of the preceding sentence, a residence will be deemed to be rented during any period that the taxpayer holds the residence out for rental or resale or repairs or renovates the residence with the intention of holding it out for rental or resale.
(iv) Election of second residence. A taxpayer may elect a different residence (other than the taxpayer's principal residence) to be the taxpayer's second residence for each taxable year. A taxpayer may not elect different residences as second residences at different times of the same taxable year except as provided below—
(A) If the taxpayer acquires a new residence during the taxable year, the taxpayer may elect the new residence as a taxpayer's second residence as of the date acquired;
(B) If property that was the taxpayer's principal residence during the taxable year ceases to qualify as the taxpayer's principal residence, the taxpayer may elect that property as the taxpayer's second residence as of the date that the property ceases to be the taxpayer's principal residence; or
(C) If property that was the taxpayer's second residence is sold during the taxable year or becomes the taxpayer's principal residence, the taxpayer may elect a new second residence as of such day.
(4) Allocations between residence and other property—(i) In general. For purposes of this section, the adjusted purchase price and fair market value of property must be allocated between the portion of the property that is a qualified residence and the portion that is not a qualified residence. Neither the average balance of the secured debt nor the interest paid or accrued on secured debt is so allocated. Property that is not used for residential purposes does not qualify as a residence. For example, if a portion of the property is used as an office in the taxpayer's trade or business, that portion of the property does not qualify as a residence.
(ii) Special rule for rental of residence. If a taxpayer rents a portion of his or her principal or second residence to another person (a “tenant”), such portion may be treated as used by the taxpayer for residential purposes if, but only if—
(A) Such rented portion is used by the tenant primarily for residential purposes,
(B) The rented portion is not a self-contained residential unit containing separate sleeping space and toilet and cooking facilities, and
(C) The total number of tenants renting (directly or by sublease) the same or different portions of the residence at any time during the taxable year does not exceed two. For this purpose, if two persons (and the dependents, as defined by section 152, of either of them) share the same sleeping quarters, they shall be treated as a single tenant.
(iii) Examples.
(5) Residence under construction—(i) In general. A taxpayer may treat a residence under construction as a qualified residence for a period of up to 24 months, but only if the residence becomes a qualified residence, without regard to this paragraph (p)(5)(i), as of the time that the residence is ready for occupancy.
(ii) Example. X owns a residential lot suitable for the construction of a vacation home. On April 20, 1987, X obtains a mortgage secured by the lot and any property to be constructed on the lot. On August 9, 1987, X begins construction of a residence on the lot. The residence is ready for occupancy on November 9, 1989. The residence is used as a residence within the meaning of paragraph (p)(3)(iii) of this section during 1989 and X elects to treat the residence as his second residence for the period November 9, 1989, through December 31, 1989. Since the residence under construction is a qualified residence as of the first day that the residence is ready for occupancy (November 9, 1987), X may treat the residence as his second residence under paragraph (p)(5)(i) of this section for up to 24 months of the period during which the residence is under construction, commencing on or after the date that construction is begun (August 9, 1987). If X treats the residence under construction as X's second residence beginning on August 9, 1987, the residence under construction would cease to qualify as a qualified residence under paragraph (p)(5)(i) on August 8, 1989. The residence's status as a qualified residence for future periods would be determined without regard to paragraph (p)(5)(i) of this section.
(6) Special rule for time-sharing arrangements. Property that is otherwise a qualified residence will not fail to qualify as such solely because the taxpayer's interest in or right to use the property is restricted by an arrangement whereby two or more persons with interests in the property agree to exercise control over the property for different periods during the taxable year. For purposes of determining the use of a residence under paragraph (p)(3)(iii) of this section, a taxpayer will not be considered to have used or rented a residence during any period that the taxpayer does not have the right to use the property or to receive any benefits from the rental of the property.
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Treas. Reg. §1.163-10T(q)Special rules for tenant-stockholders in cooperative housing corporations—(1) In general.
Special rules for tenant-stockholders in cooperative housing corporations—(1) In general. For purposes of this section, a residence includes stock in a cooperative housing corporation owned by a tenant-stockholder if the house or apartment which the tenant-stockholder is entitled to occupy by virtue of owning such stock is a residence within the meaning of paragraph (p)(3)(ii) of this section.
(2) Special rule where stock may not be used to secure debt. For purposes of this section, if stock described in paragraph (q)(1) of this section may not be used to secure debt because of restrictions under local or State law or because of restrictions in the cooperative agreement (other than restrictions the principal purpose of which is to permit the tenant-stockholder to treat unsecured debt as secured debt under this paragraph (q)(2)), debt may be treated as secured by such stock to the extent that the proceeds of the debt are allocated to the purchase of the stock under the rules of § 1.163-8T. For purposes of this paragraph (q)(2), proceeds of debt incurred prior to January 1, 1987, may be treated as allocated to the purchase of such stock to the extent that the tenant-stockholder has properly and consistently deducted interest expense on such debt as home mortgage interest attributable to such stock on Schedule A of Form 1040 in determining his taxable income for taxable years beginning before January 1, 1987. For purposes of this paragraph (q)(2), amended returns filed after December 22, 1987, are disregarded.
(3) Treatment of interest expense of the cooperative described in section 216(a)(2). For purposes of section 163(h) and § 1.163-9T (disallowance of deduction for personal interest) and section 163(d) (limitation on investment interest), any amount allowable as a deduction to a tenant-stockholder under section 216(a)(2) shall be treated as interest paid or accrued by the tenant-stockholder. If a tenant-stockholder's stock in a cooperative housing corporation is a qualified residence of the tenant-shareholder, any amount allowable as a deduction to the tenant-stockholder under section 216(a)(2) is qualified residence interest.
(4) Special rule to prevent tax avoidance. If the amount treated as qualified residence interest under this section exceeds the amount which would be so treated if the tenant-stockholder were treated as directly owning his proportionate share of the assets and liabilities of the cooperative and one of the principal purposes of the cooperative arrangement is to permit the tenant-stockholder to increase the amount of qualified residence interest, the district director may determine that such excess is not qualified residence interest.
(5) Other definitions. For purposes of this section, the terms “tenant-stockholder,” “cooperative housing corporation” and “proportionate share” shall have the meaning given by section 216 and the regulations thereunder.
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Treas. Reg. §1.163-10T(r)Effective date.
Effective date. The provisions of this section are effective for taxable years beginning after December 31, 1986.
-
Treas. Reg. §1.163-10T(v)Prevention of double counting in year of refinancing—(A) In general.
Prevention of double counting in year of refinancing—(A) In general. A debt used to pay for qualified medical or educational expenses is refinanced if some or all of the outstanding balance of the debt (the “original debt”) is repaid out of the proceeds of a second debt (the “replacement debt”). If, in the year of a refinancing, the combined qualified indebtedness of the original debt and the replacement debt exceeds the combined qualified expenses of such debts, the amount of qualified indebtedness for each such debt shall be determined by multiplying the amount of qualified indebtedness for each such debt by a fraction, the numerator of which is the combined qualified expenses and the denominator of which is the combined qualified indebtedness.
(B) Definitions. For purposes of paragraph (n)(1)(v)(A) of this section—
(1) The term “combined qualified indebtedness” means the sum of the qualified indebtedness (determined without regard to paragraph (n)(1)(v) of this section) for the original debt and the replacement debt.
(2) The term “combined qualified expenses” means the amount of the proceeds of the original debt used to pay for qualified medical and educational expenses through the end of the current taxable year, reduced by any principal payments on the debt before the first day of the current taxable year, and increased by the amount, if any, of the proceeds of the replacement debt used to pay such expenses through the end of the current taxable year other than as part of the refinancing.
(C) Example. (i) On August 11, 1987, C incurs a $8,000 debt secured by a principal residence. C uses (within the meaning of paragraph (n)(2)(i) of this section) $5,000 of the proceeds of the debt to pay for qualified educational expenses. C makes no principal payments on the debt. On July 1, 1988, C incurs a new debt in the amount of $8,000 secured by C's principal residence and uses all of the proceeds of the new debt to repay the original debt. Under paragraph (n)(2)(ii) of this section $5,000 of the new debt is treated as being used to pay for qualified educational expenses. C makes no principal payments (other than the refinancing) during 1987 or 1988 on either debt and pays all accrued interest monthly. The average balance of each debt in 1988 is $4,000.
(ii) Under paragraph (n)(1)(iii) of this section, the amount of qualified indebtedness for 1988 with respect to the original debt is $4,000 (the lesser of its average balance ($4,000) and the amount of the debt used to pay for qualified medical and educational expenses ($5,000)). Similarly, the amount of qualified indebtedness for 1988 with respect to the replacement debt is also $4,000. Both debts, however, are subject in 1988 to the limitation in paragraph (n)(1)(v)(A) of this section. The combined qualified indebtedness, determined without regard to the limitation, is $8,000 ($4,000 of qualified indebtedness from each debt). The combined qualified expenses are $5,000 ($5,000 from the original debt and $0 from the replacement debt). The amount of qualified indebtedness from each debt must, therefore, be reduced by a fraction, the numerator of which is $5,000 (the combined qualified expenses) and the denominator of which is $8,000 (the combined qualified indebtedness). After application of the limitation, the amount of qualified indebtedness for the original debt is $2,500 ($4,000 × ×
5/8). Similarly, the amount of qualified indebtedness for the replacement debt is $2,500. Note that the total qualified indebtedness for both the original and the replacement debt is $5,000 ($2,500 + $2,500). Therefore, C is entitled to the same amount of qualified indebtedness as C would have been entitled to if C had not refinanced the debt.
(vi) Special rule for principal payments in excess of qualified expenses. For purposes of paragraph (n)(1)(iii)(B), (n)(1)(v)(B)(2) and (n)(2)(ii) of this section, a principal payment is taken into account only to the extent that the payment, when added to all prior payments, does not exceed the amount used on or before the date of the payment to pay for qualified medical and educational expenses.
(2) Debt used to pay for qualified medical or educational expenses—(i) In general. For purposes of this section, the proceeds of a debt are used to pay for qualified medical or educational expenses to the extent that—
(A) The taxpayer pays qualified medical or educational expenses within 90 days before or after the date that amounts are actually borrowed with respect to the debt, the proceeds of the debt are not directly allocable to another expense under § 1.163-8T(c)(3) (allocation of debt; proceeds not disbursed to borrower) and the proceeds of any other debt are not allocable to the medical or educational expenses under § 1.163-8T(c)(3), or
(B) The proceeds of the debt are otherwise allocated to such expenditures under § 1.163-8T.
(ii) Special rule for refinancings. For purposes of this section, the proceeds of a debt are used to pay for qualified medical and educational expenses to the extent that the proceeds of the debt are allocated under § 1.163-8T to the repayment of another debt (the “original debt”), but only to the extent of the amount of the original debt used to pay for qualified medical and educational expenses, reduced by any principal payments on such debt up to the time of the refinancing.
(iii) Other special rules. The following special rules apply for purposes of this section.
(A) Proceeds of a debt are used to pay for qualified medical or educational expenses as of the later of the taxable year in which such proceeds are borrowed or the taxable year in which such expenses are paid.
(B) The amount of debt which may be treated as being used to pay for qualified medical or educational expenses may not exceed the amount of such expenses.
(C) Proceeds of a debt may not be treated as being used to pay for qualified medical or educational expenses to the extent that:
(1) The proceeds have been repaid as of the time the expense is paid;
(2) The proceeds are actually borrowed before August 17, 1986; or
(3) The medical or educational expenses are paid before August 17, 1986.
(iv) Examples—
(3) Qualified medical expenses. Qualified medical expenses are amounts that are paid for medical care (within the meaning of section 213(d)(1) (A) and (B)) for the taxpayer, the taxpayer's spouse, or a dependent of the taxpayer (within the meaning of section 152), and that are not compensated for by insurance or otherwise.
(4) Qualified educational expenses. Qualified educational expenses are amounts that are paid for tuition, fees, books, supplies and equipment required for enrollment, attendance or courses of instruction at an educational organization described in section 170(b) (1)(A)(ii) and for any reasonable living expenses while away from home while in attendance at such an institution, for the taxpayer, the taxpayer's spouse or a dependent of the taxpayer (within the meaning of section 152) and that are not reimbursed by scholarship or otherwise.
322 Citing Cases
Section 163 provides that “[t]here shall be allowed as a deduction all interest paid or accrued within the taxable year on indebtedness.” SLS, an S corporation, claimed deductions for interest allegedly accruing on the 2014 and 2016 notes.
small business corporation (as defined in section 1371(b))” was struck from section 183(a) and “an S corporation” was inserted in its place. Subchapter S Revision Act of 1982, Pub. L. No. 97-354, § 5(a)(23), 96 Stat. 1669, 1694. 22 [*22] interest (sec. 163), and taxes (sec. 164). Viewed in the context of its position in part VI, section 183 is simply a statute that allows certain deductions attributable to “activities not engaged in for profit” in computing taxable income under section 63(a). S
2015-42), supplementing and overruling in part 147 T.C.
Section 163 is unambiguous in providing that the mortgage interest deduction is allowed only for interest paid on the outstanding mortgage balance secured by the taxpayer’s home. See § 163(h)(3)(A) (providing a deduction for interest paid on debt incurred to buy, build/improve, or borrow against a taxpayer’s home when the debt is secured by the hom
Petitioner must satisfy the following three requirements to be entitled to a deduction pursuant to section 163(a) and (h)(2)(D): (1) the indebtedness must be his obligation, (2) he must either be the legal or equitable owner of the property subject to the mortgage, and (3) the residence is his qualified residence.
§ 6221(a) and Tax Court Rule 240(c), we have jurisdiction to determine whether WTS and PLI were engaged in a joint venture constituting a partnership for federal income tax purposes, and we hold that they were not so engaged.
estate would eventually owe tax on what it got back from the Insurance Trust through the receivable the Estate held, and that tax would shrink if Levine’s basis in the receivable increased.16 15 While interest paid can be deducted from income under section 163, section 264 denies this deduction to the extent that the money is borrowed to fund a life- insurance policy, and in effect defers the deduction until the policy matures.
Petitioner has failed, however, to provide any explanation for the business nature of this interest expense or any substantiation that it was actually paid. He has failed to meet his burden of proof, see Hradesky v. Commissioner, 65 T.C. at 90 (disallowing claimed deductions when there was “no substantiation at all”), or provide a reasona
17 We overrule the Commissioner’s objection to Whatley’s introduction of evidence in support of this argument.
Mortgage interest¹² 1. General principles Section 163(h)(3) provides that interest on a qualified residence is deductible by non-corporate taxpayers. Qualified residence interest encompasses interest payments on two types ofdebt: acquisition indebtedness and home equity indebtedness. Sec. 163(h)(3)(A). "Acquisition indebtedness" genera
d bills for utilities and insurance. Petitioners apparently had an option to acquire the Wingate property, but they never exercised that option. They cannot deduct rent, substitutes for rent, or per- sonal living expenses as "mortgage interest." See sec. 163; Puentes v. Commis- sioner T.C. Memo. 2013-277, 106 T.C.M. (CCH) 646, 647 ("We have disallowed the deduction for mortgage interest where the taxpayer does not establish legal or - 16 - [*16] equitable ownership ofmortgaged property."); sec.
2015-42; see also Graev v.
To meet the requirements ofsection 163, the mortgage must be the obligation ofthe taxpayer claiming the deduction, not the obligation ofanother.
After concessions, the issues for decision are whether petitioner for tax year 2010: (1) is liable for self-employmenttax under section 1401; (2) is entitled to an interest expense deduction under section 163; (3) is entitled to a business expense deduction under section 162;² and (4) is liable for additions to tax under sections 6651(a)(1) and (2) and 6654(a).3 FINDINGS OF FACT Some ofthe facts are stipulated and are so found.
A "qualified residence" for purposes ofsection 163 includes the taxpayer's primary residence and one other home "which is used by the taxpayer as a resi- dence (within the meaning ofsection 280A(d)(1))." To meet the latter require- ment the taxpayer must use the home "for personal purposes for a period exceed- ing the greater of 14 days or 10% ofthe number ofdays during the year for whi
losed tax years related to accrued interest; (5) whether alternativelypetitioner is entitled to reduce income by the amount ofinterest income accrued but unpaid; (6) whether petitioner is entitled to an unrelated-partybad debt deduction under section 166 for tax year 2007; and (7) whether petitioner is entitled to interest expense deductions under section 163 for tax years 2009-13.¹ FINDINGS OF FACT Some ofthe facts have been stipulated and are so found.
losed tax years related to accrued interest; (5) whether alternativelypetitioner is entitled to reduce income by the amount ofinterest income accrued but unpaid; (6) whether petitioner is entitled to an unrelated-partybad debt deduction under section 166 for tax year 2007; and (7) whether petitioner is entitled to interest expense deductions under section 163 for tax years 2009-13.¹ FINDINGS OF FACT Some ofthe facts have been stipulated and are so found.
Stanley acknowledged that petitioners used some ofthe loan proceeds to pay personal expenses, and petitioners made no attempt to distinguish between those loan proceeds used for personal expenses and those used for other purposes that might permit deduction. We likewise have insufficient evidence to make any reasonable allocation between payment ofpersonal expenses and other uses. See Sec. 1.163-8T(a)(3), Temporary Income Tax Regs., 52 Fed.
Section 163 allows taxpayers a deduction for "qualified residence interest" paid on the mortgage on their first or secondaryhome. Sec. 163(a), (h)(2)(D); sec. 1.163-10T(b), Temporary Income Tax Regs., 52 Fed. Reg. 48410 (Dec. 22, 1987). Qualified residence interest is either "acquisition indebtedness" or "home equity indebtedness." Sec. 163(h)(3)(A
Section 163 allows a taxpayerto deduct interest paid or incurred within the taxable year on indebtedness. Respondent argues that we should not allow ADI its interest deduction since it paid the $772 in furtherance ofa tax-motivated transaction lacking economic substance. See, e.g., Winn-Dixie Stores, Inc. v. Commissioner, 113 T.C. 254, 294 (1999),
For purposes ofsection 163, "property held for investment" includes property which produces income such as interest, dividends, annuities, and - 7 - [*7] royalties, and is not derived in the ordinary course ofa trade or business.
For purposes ofsection 163, "property held for investment" includes property which produces income such as interest, dividends, annuities, and - 7 - [*7] royalties, and is not derived in the ordinary course ofa trade or business.
For purposes ofsection 163, "property held for investment" includes property which produces income such as interest, dividends, annuities, and - 7 - [*7] royalties, and is not derived in the ordinary course ofa trade or business.
Unlike interest, the late fee does not accrue periodically but is instead charged only once. Regardless of whether the late fees are deductible as interest under sec. 163, because oftheir nexus to CHMD's acquisition ofequipment used in the operation ofits medical practice, they qualify as ordinary and necessary business expenses and would be deductible under sec.
Section 163 allows taxpayers a deduction for "qualified residence interest" paid on the mortgage on their first or secondaryhome. Sec. 163(a), (h)(2)(D); sec. 1.163-10T(b), Temporary Income Tax Regs., 52 Fed. Reg. 48410 (Dec. 22, 1987). Qualified residence interest is either "acquisition indebtedness" or "home equity indebtedness." Sec. 163(h)(3)(A
o borrowed repeatedly and regularly against the annuity's cash value, such that "the net cash value, on which any annuity or insurance payments would depend," remained negligible. E at 366. He claimed a deduction for interest paid on the loans under sec. 163. Id. at 363- 364. Quoting Gregory, the Court asked "'whetherwhat was done, apart from the tax motive, was the thing which the statute intended'" and concluded the answer was no. E at 365 (quoting Gregory v. Helvering, 293 U.S. at 469). The a
Section 163 allows a taxpayerto deduct interest paid or incurred within the taxable year on indebtedness. Respondent argues that we should not allow ADI its interest deduction since it paid the $772 in furtherance ofa tax-motivated transaction lacking economic substance. See, e.g., Winn-Dixie Stores, Inc. v. Commissioner, 113 T.C. 254, 294 (1999),
borrowed repeatedly and regularly against the annuity’s cash value, such that “the net cash value, on which any annuity or insurance payments would depend,” remained negligible. Id. at 366. He claimed a deduction for interest paid on the loans under sec. 163. Id. at 363-364. Quoting Gregory, the Court asked “‘whether what was done, apart from the tax motive, was the thing which the statute intended’” and concluded the answer was no. Id. at 365 (quoting Gregory v. Helvering, 293 U.S. at 469). The
Section 163(h)(1), however, provides that, in the case ofa taxpayer other than a corporation, no deduction shall be allowed for personal interest.
' Section 163(h)(3)(A) defines qualified residence interest as any interest paid or accrued during the taxable year on: (i) acquisition indebtedness with respect to any qualified residence of the taxpayer, or (ii) home equity indebtedness with respect to any qualified residence of the taxpayer. Acquisition indebtedness is debt!incur
Accordingly, we hold that petitioner is not entitled to a deduction under section 163 for the $6,017.62 ofpoints paid.
Section 163 generally allows a d duction for all interest paid or accrued within the taxable year on indebtedness Sec. 163(a). However, no deduction is allowed for personal interest paid·or ac rued during the taxable year·únless specifically allowed by statute. Sec. 16 (h). Among the enumerated items of deductible personal interest is qualified esi
The parties have stipulated that the "acquisition indebtedness" within the meaning ofsection 163 with respect to the Michigan property was $468,397 in 2006 and $483,095 in 2007.
Section 163 allows a deduction for interest paid or accrued on certain indebtedness, including acquisition indebtedness with respect to the taxpayer's personal residence. Sec. 163(a), (h)(2)(D), (3)(A)(i), (4)(A)(i). Section 1.163-1(b), Income Tax Regs., provides in pertinent part: "interest paid by the taxpayer on a mortgage upon real estate ofwhi
ioner, T.C. Memo. 1978- 474, 1978 Tax Ct. Memo LEXIS 39, at *8, aff'd without published opinion, 618 F.2d 98 (4th Cir. 1980); Phillips v. Commissioner, T.C. Memo. 1972-21, 1972 Tax - 25.- [*25] Ct:Memo LEXIS 235, at *4. Interest paid is deductible, sec. 163,:but Azimzadeh didn't show that any part ofthe payihent was for interest. . Section 274(d) also imposes stricter substäntiation requirements for travel expenses.uA taxpayer has to show, with records or with sufficient records corroborating th
And again, ifthe issue was not clear enough from the ruling itself, it was further emphasized by the major heading in the Cumulative Bulletin under which the ruling was printed: "Section 163.--Interest".
Year Deficiency 6651(a)(1) 6651(a)(2) 6654 2002 $10,672 $2,401.20 $2,668.00 $356.63 2003 10,871 2,445.98 2,717.75 280.51 2004 11,488 2,584.80 2,872.00 329.24 2005 12,957 (cid:16)042 2,915.33 2,461.83 519.75 2006 14,132 3,179.70 1,837.16 668.81 2007 24,122 5,427.45 1,668.54 1,097.84 Respondent conceded at trial that petitioner was entitled to section 163 deductions for mortgage interest as well as section 164 deductions for real estate taxes paid for the years at issue.
Section 163 allows a deduction for "all interest paid or accrued within the taxable year on indebtedness." Sec. 163(a). To be deductible, however, the interest must be on a genuine debt owed by the taxpayer. Knetsch v. United - 28 - [*28] States, 364 U.S. 361, 365 (1960); Midkiffv. Commissioner, 96 T.C. 724, 735 (1991), aff'd sub nom. Noguchi v. C
Federal income tax purposes by Frito-Lay, PepsiCo, and Metro Bottling pursuant to section 163.
This determination, unlike respondent's position on brief, is consistent with Rev. Rul. 2010-25, 2010- 44 I.R.B. 571, which holds that ifa loan that otherwise would be acquisition indebtedness exceeds the $1 million cap, the excess may be treated as home equity indebtedness. This Court has held that sec. 163(h) restricts the residential mortgage interest deduction to interest paid on $1 million ofacquisition (continued...) - 26 - [*26] acquisition indebtedness should be allocated to investmentp
Print 2005) ("The additional first-year depreciation deduction is subject to the general rules regarding whether an item is deductible under section 162 or subject to capitalization under section 163 or section 263A.").
Although section 163 generally allows deductions for interest on indebtedness, the indebtedness must generally be an obligation ofthe taxpayer, and not an obligation ofanother.
As a result, we disagree with.petitionerthat the requirements ofsection 6664(c)(1) are satisfied because of"confusion" in the interpretation ofsection 163(h)(3)(B)(ii) and (C)(ii).
Section 163 generally allows a deduction for "all interest paid or accrued within the taxable year on indebtedness." Sec. 163(a). Section 163(a) has its own exceptions, and one of them, section 163(h), says that an individual taxpayer may not deduct personal interest. See sec. 163(h) (1). The exception has its own exception, and.excludes from the d
We hold that he is entitled to $1,950 oftae disputedtravel expenses for 2006 and $73 ofthe disputed travel expenses for 2007; (3) whetherpetitioner is entitled to disputed Schedule C deductions for meal and entertainment expenses ofS9,955 and $1,887 for 2006 and 2007, respectively.
Petitioner claims that section 163 and the legislative history provide both substantial authority and a reasonable basis for her treatment of the mortgage interest paid.
e corporation under section 164 which are paid or incurred by the corporation on the houses or apartment building and on the land on which such houses (or building) are situated, or (2) the interest allowable as a deduction to the corporation under section 163 which is paid or incurred by the corporation on its indebtedness contracted-- (A) in the acquisition, construction, alteration, rehabilitation, or maintenance of the houses or apartment building, or ()B) in the acquisition of the land on w
hich the taxpayer himself doesn' t materially participate, interest he pays on the loan is "investment interest." The term also. includes the interest someone pays on a loan whose proceeds he uses to buy an asset that yields- "portfolio income." See sec. 163 (d) (3) (A)v, (5) (A) . "Portfolio income" includes most types of passive income, such as interest and dividends. - 7 - On August 4, 2010, the Commissioner reported that Thompson's communication was minimal. To his credit, Thompson then did
163 (h) (2) (D). - Deductible interest includes interest from both acquisition and home equity indebtedness. Sec. 163(h) (3). Petitioner claimed a mortgage interest deduction of $54,356 on her return. At trial, petitioner made no argument and provided no substantiation for the portion thereof that respondent disallowed ($17,527). In view of th
Home Interest and Property Taxes Petitioner claims section 163 deductions for interest paid on the loan financing the construction of the house petitioner planned to live in with Ms.
We hold that no interest accrued on the Merrill loan is properly allocable to the Intel stock as investment property.3 Petitioners finally argue that section 1.163-8T(c) (1), Temporary Income Tax Regs., supra, is invalid because it conflicts with section 163(d) (3) (A).
Qualified residence interest is any interest that is paid or accrued during the taxable year on acquisition indebtedness or home equity indebtedness. See sec. 163(h) (3) (A). Acquisition indebtedness is any indebtedness secured by the qualified residence of the taxpayer and incurred in acquiring, constructing, or substantially
itution of documents causing someone to sign an instrument without knowing the consequences of his act.'" Id. at 1186-1187 (quoting Meyers v. Johanningmeier, 11 Brief Times Reporter 122 (Feb. 6, 1987)). Quoting the Restatement (Second) of Contracts, sec. 163 Illustration 2 (1981), the court explained by way of example: A and B reach an understanding that they will execute a written contract containing terms on which they have agreed.. It is properly prepared and is read by B, but A substitutes a
hich the taxpayer himself doesn' t materially participate, interest he pays on the loan is "investment interest." The term also. includes the interest someone pays on a loan whose proceeds he uses to buy an asset that yields- "portfolio income." See sec. 163 (d) (3) (A)v, (5) (A) . "Portfolio income" includes most types of passive income, such as interest and dividends. - 7 - On August 4, 2010, the Commissioner reported that Thompson's communication was minimal. To his credit, Thompson then did
163 (h) (3) (A). Acquisition indebtedness means any indebtedness that is incurred in acquiring, constructing, or substantially improving any qualified residence of the taxpayer and is secured by the - 6 - residence. Sec. 163(h) (3) (B) (i). A qualified residence includes the principal residence of the taxpayer. Sec. 163(h) (4) (A). Generally,
he corporation under section 164 which are paid or incurred by the corporation on the houses or apartment building and on the land on which such houses (or building) are situated, or (2) the interest allowable as a deduction to the corporation under section 163 which is paid or incurred by the corporation on its indebtedness contracted— (A) in the acquisition, construction, alteration, rehabilitation, or maintenance of the houses or apartment building, or (B) in the acquisition of the land on wh
redemption elections if they received payments resembling the interest payments . P deducted these payments, and R disallowed the deductions for 2004 and 2005. Held: The payments in question were not interest and therefore were not deductible under sec. 163, I.R.C. Held, further, all payments in 2004 were deductible under sec. 162, I.R.C., and the 12-month rule of sec. 1.263(a)-4(f) (5) (i), Income Tax Regs. However, payments in 2005 were not deductible to the - 2 - extent that sec. 1.263(a)-4(
6662(a) 2003 $38,020 $6,304 .00 $7,604 2004 20,705 1,983 .25 4,141 SERVED Apr 13 2010 _ 2 As an initial matter, neither party argued or briefed whether : (1) The Essex Drive trust, should have claimed th e mortgage interest deduction pursuant to section 163 (h) (4) (D) 1 and the provisions of subchapter J ; (2) petitioner could have claimed the mortgage interest deduction as investment interest, Davies v .
After concessions, the issues for decision are : (i) whether amounts paid by the Nelsons' limited liability companies are deductible, either as fees pursuant to section 162 or as interest expenses pursuant-to section 163 ; and (ii) whether the Nelsons are liable for the accuracy-related penalty pursuant to .-section 6662(a) .
Schedule A--Home Mortgage Interest Section 163 allows a tax deduction for interest paid on the mortgage of.a taxpayer's primary or secondary residence.
Y 4 - 3 - payments t taling $31,709 under section 163 as either interest accrued in connection with a trade or business or as qualified residence nterest .
Petitioner deducted the 2004 forbearance payment on its 2004 corporate tax return as an interest expense under section 163 and deducted the 2005 amount on its 2005 return as a forbearance expense under section 162.
The "indebtedness" for-purposes of section 163 must., in general, be an obligation of the taxpayer and not an obligation of another .
Section 163 ( h) provides that .no deduction „shall , be allowed for personal- inter'est' .paid or accrued during the.-taxable year .
Section 163 allows as a deduction all interest paid within the taxable year on indebtedness . Section 163(h)(1), .however; provides : "In the case~of a taxpayer other than a corporation, no deduction shall .be .allowed under this chapter for personal interest paid *,* * during the taxable year ." For this purpose, personal interest d-oes not-includ
Interest, Expense s Section 163 allows a deduction for interest on indebtedness paid or accrued within the+taxable year .
The "indebtedness" for-purposes of section 163 must., in general, be an obligation of the taxpayer and not an obligation of another .
The "indebtedness" for purposes of section 163 must, in general, be an obligation of the taxpayer and not an obligation of another .
tion 404(k), their deduction should be disallowed as evasions of taxation under section 404(k)(5); and (3) even if the redemption dividends are otherwise allowable as deductions under section 404(k), they are disallowed as amounts paid by a corporation in connection with the redemption of its stock within the meaning of section 162(k).
"Qualified residence" within the meaning of section 163 is the taxpayer's principal place of residence .
— Any— (i) deduction allowable under section 163 (relating to interest), or (ii) deduction for dividends paid (within the meaning of section 561).
"Qualified residence" within the meaning of section 163 may be either the taxpayer's principal residence or another residence selected by the taxpayer and used as a residence .
of the property . As we understand his position, petitioner contends that he is entitled to claim these deductions because he paid the mortgage payments and all of the bills associated with the house . Deduction for Mortgage Interes t In general, section 163. allows a deduction for interest paid or accrued on indebtedness . For taxpayers who are not corporations, section 163(h)(1) disallows a deduction for personal interest . Interest paid on a mortgage .secured by a qualified residence, howeve
nd find it to be sufficient to sustain the deduction because the exhibit in the record establishes the $1,000 payment . The largest amounts in dispute in 2000 and 2001 are for investment interest . The deduction of investment interest is governed by section 163 . Petitioner deducted $17,358 and $46,792, respectively . Respondent allowed $4,007 and $3,731, respectively. Section 163(d)(1) limits the investment interest deduction to the net investment income for the year, which would come into play
On the basis of third party information returns, respondent also concedes that under section 163 petitioner is entitled to Schedule A deductions for mortgag interest expenses in the amounts of $22,000, $18,933, $17,909, nd $16,661 for taxable years 2000, 2001, 2002, and 2003, res ectively .
Respondent concedes that petitioners are entitled to deduct the following expenses totaling $243,363 as itemized deductions: (1) $37,738, identified by petitioners as "Option Int" for "US Bank Corp.", as investment interest expenses under section 163; (2) $186,370, idenhified by petitioners as "Option Int" for "Merrill Lynch", as investment interest expenses under section 163; and (3) $19,255 of the $20,164 identified by petitioners as "Opt.int" for "Merrill Lynch", as investment interest expens
- 4 - Mortgage Interest Deduction Section 163 allows a deduction for interest paid or accrued on certain indebtedness, including acquisition indebtedness on a qualified residence.
OPINION Interest and Property Tax Payments (cid:16)042 Under section 163, interest paid on a mortgage relating to a qualified residence generally is deductible.
Neither section 163 (relating to interest) nor section 165 (relating to losses) shall apply with respect to such a payment. (b) Payment treated as worthless nonbusiness debt. This paragraph applies to taxpayers (other than corporations) who, after December 31, 1975, enter into a transaction for profit, but not in the course of their trade or business, to a
claim” to characterize the transfer of the contract for deed as alimony. 10This general rule does not apply to those expenses that are deductible regardless of any connection with a trade or business, such as mortgage interest on the residence under sec. 163, real estate taxes under sec. 164, or casualty losses under sec. 165. Sec. 280A(b). - 11 - of the number of days the unit is rented at fair rental value, no deduction is allowed. Sec. 280A(a), (d)(1). Nor may taxpayers deduct expenses for th
mpensation acts as compensation for personal injuries or 3The term “points” refers to a fee, generally equal to a percentage of the total loan, which is paid to the lending institution to lower the interest rate. They are classified, for purposes of sec. 163, as “prepaid interest”. - 5 - sickness.” Petitioners argue that, since Mr. Hurley was only 70 percent capable for the work that he was once 100 percent able to do, it followed that 30 percent of the wages he received was attributable to work
Respondent agrees that petitioners are entitled to deduct, under section 163, $4,796 of the claimed deduction for home mortgage interest.
has offered no evidence concerning whether this amount represents prepaid interest or instead a payment for services rendered by (cid:16)04t2he financial institution that provided the financing. Thus, this amount is not deductible as interest under section 163. Goodwin v. Commissioner, 75 T.C. 424, 440-442 (1980), affd. 691 F.2d 490 (3d Cir. 1982); Wilkerson v. Commissioner, 70 T.C. 240, 253 (1978), revd. on another issue 655 F.2d 980 (9th Cir. 1981); Enoch v. Commissioner, 57 T.C. 781, 794-795
163 (h) (3) (B) (i) (II) and (C) (i) . - 16 - The amount petitioner borrowed against his insurance policy was not secured by his house. We conclude that any interest paid on this loan is not deductible. Sec. 163(h). Accordingly, we sustain respondent's determination to disallow $6,862 of petitioner's home mortgage interest deduction for 2000.
f claim” to characterize the transfer of the contract for deed as alimony. This general rule does not apply to those expenses that are deductible regardless of any connection with a trade or business, such as mortgage interest on the residence under sec. 163, real estate taxes under sec. 164, or casualty losses under sec. 165. Sec. 280A(b). Petitioners vaguely assert that she stayed on a “single occasion.” Nor have petitioners carried their burden to prove that they rented the unit for at least
nder section 2(b) for the year 2000; (2) whether petitioner is entitled to claim a child care credit under section 21 for the year 2000; (3) whether petitioner is entitled to itemized deductions of $6,766 and $8,100 for home mortgage interest under section 163 for the years 2000 and 2001, respectively; (4) whether petitioner is entitled to itemized deductions of $10,307 and $16,680 for charitable contributions under section 170 for the years 2000 and 2001, respectively; (5) whether petitioner is
Cutts is entitled to deduct the portion of constructive interest payments allocable to ATV’s payments on the Landmark Hall mortgage to the extent allowable under section 163, which is to be determined in the Rule 155 computation.
ar, to the extent that the amounts represent the tenant-stockholder's proportionate share of (1) the real estate taxes deductible by the corporation under section 164, sec. 216(a)(1), and (2) the mortgage interest deductible by the corporation under section 163, sec. 216(a)(2).3 2 Sec. 164(a) provides in pertinent part: SEC. 164. TAXES. (a) General Rule.--Except as otherwise provided in this section, the following taxes shall be allowed as a deduction for the taxable year within which paid or ac
The "indebtedness" for purposes of section 163 must, in general, be an obligation of the taxpayer and not an obligation of another.
Cutts is entitled to deduct the portion of constructive interest payments allocable to ATV’s payments on the Landmark Hall mortgage to the extent allowable under section 163, which is to be determined in the Rule 155 computation.
The issues for decision are whether petitioner is entitled to a deduction under section 166 for a bad debt loss in 1999; whether petitioner is entitled to an interest expense deduction under section 163; whether petitioner is liable for the addition to tax for failure to file under section 6651(a)(1); and whether a penalty should be awarded to the United States under section 6673 by reason of petitioner’s failure to exhaust his administrative remedies.
ar, to the extent that the amounts represent the tenant-stockholder’s proportionate share of (1) the real estate taxes deductible by the corporation under section 164, sec. 216(a)(1), and (2) the mortgage interest deductible by the corporation under section 163, sec. 216(a)(2). Section 55 provides for an alternative minimum tax (AMT). In computing alternative minimum taxable income (amti), no deduction is allowed to an individual for, inter alia, miscellaneous itemized deductions (as defined in
in control, if the Retained Executives continued to work for petitioner until the vesting of their rights to these payments. Further, the parties have stipulated that the interest component of the 1991 SRP Benefits is deductible by petitioner under sec. 163 in 1992 and does not constitute a "parachute payment" within the meaning of sec. 280G. For convenience, we hereinafter refer to the portion of the 1991 SRP Benefits whose deductibility remains in dispute as the "disputed 1991 SRP Benefits" a
We hold as a matter of law that petitioners’ capital losses and capital loss carryovers are an integral part of the equation in calculating investment income under section 163(d)(4)(B).
Permitting amortization deductions on the basis of this intangible asset does not run afoul of the interest deduction rules of section 163 or the OID rules. We cannot agree with respondent that petitioner’s claimed amortization deductions are in effect a substitute for interest. In support of his argument that petitioner is attempting to circumvent the rules for deducting interest and OID, respondent directs our attention to section 197 where Congress specifically expressed its intent that below
We sustained the Commissioner’s disallowance of - 44 - the deduction on the grounds that no indebtedness for purposes of section 163 existed, concluding instead that the 5 percent “interest” was merely part of the purchase price of the stock.
in control, if the retained executives continued to work for petitioner until the vesting of their rights to these payments. Further, the parties have stipulated that the interest component of the 1991 SRP Benefits is deductible by petitioner under sec. 163 in 1992 and does not constitute a “parachute payment” within the meaning of sec. 280G. For convenience, we hereinafter refer to the portion of the 1991 SRP Benefits whose deductibility remains in dispute as the “disputed 1991 SRP Benefits” a
Respondent also argues that petitioner’s claiming of amortization deductions with respect to its financing arrangements constitutes an impermissible “loop” around the interest deductions rules of section 163 and the rules applicable to original issue discount (OID).
We hold that it does.
The “indebtedness” for purposes of section 163 must, in general, be an obligation of the taxpayer and not an obligation of another.
In Reise we thereupon overruled Aaron and reaffirmed the position we took in Polk that the interest on the tax underpayment was attributable to the taxpayer’s trade or business.
In section 163 no distinction is made between interest paid on business-related indebtedness owed by individual taxpayers and interest paid on business-related indebtedness owed by other types of taxpayers. Respondent’s temporary regulation, however, provides that interest paid specifically on income tax liabilities of individuals, regardless of the s
The Parties’ Contentions The parties focus their dispute on whether section 163 prohibits allowance of petitioners’ claimed $69,617 Schedule C interest deduction; in particular whether the interest is “on indebtedness properly allocable to a trade or business”, within the meaning of section 163(h)(2)(A), and therefore exempt from the general disallowance rule of section 163(h).
lation’s fungibility concept”. Finally, respondent argues that petitioner’s position ignores the fact that the regulations promulgated under section 861 apportion “deductions” which, in the case of interest expenses means the amount deductible under section 163. In this connection, respondent points out that section 1.861-8(a)(2), Income Tax Regs., is headed “Allocation and apportionment of deductions in general”, and that “there is nothing in the Regulations suggesting that the word ‘deduction’
On the record before us, we find that petitioner has failed to carry his burden of establishing that he is entitled under section 163 to deduct (1) for 1991 and 1992 interest payments of $1,632.18 and $1,176.48, respectively, that he made during those years on petitioner’s equity line account and (2) for 1992 the claimed interest payment of $1,250.
The "indebtedness" for purposes of section 163 must, in general, be an obligation of the taxpayer and not an obligation of another.
taxpayer must establish the 3 At trial, near the conclusion of petitioner's case-in- chief, petitioner’s counsel stated that petitioner would not be relying on the alternative theory that petitioner was entitled to interest expense deductions under sec. 163. As a result, respondent limited his cross-examination of at least one of petitioner's witnesses and rested without offering any witnesses of his own. Thereafter, petitioner resurrected and argued the sec. 163 issue on brief in spite of its
(Petitioners did not elect to itemize deductions on their 1994 return.) Nevertheless, because of the amount of gross income earned by petitioners in - 11 - their horse racing activity, mortgage interest is not allowable as a trade or business deduction on the Schedule F. In general no deduction is allowed for “any amount paid out for
d COLI program lacked economic substance and business purpose (other than tax reduction) and is therefore a sham for tax purposes. As a result, interest on P's COLI policy - 2 - loans is not deductible interest on indebtedness within the meaning of sec. 163, I.R.C. The administrative fees associated with the COLI program are not deductible because they were incurred in furtherance of a sham. Michael J. Henke, Tegan M. Flynn, Cary D. Pugh, Thomas Crichton IV, Robert H. Cox, and Thomas P. Marinis,
1998-92, the Court of Appeals for the Seventh Circuit sua sponte raised the issue of the degree of deference owed to temporary interpretive regulations issued by respondent under section 163 without notice and comment procedures.
r that the transactions purportedly generating the claimed amounts resulted either in any bona fide indebtedness or in any enforceable and bona fide obligation to pay compensation for use or forbearance of money on indebtedness within the meaning of I.R.C. Section 163. Furthermore, if it is established that any portion of the above disallowed "interest" is a properly 10 In some instances, respondent's notices of deficiency listed specific Kersting corporations under "Purported Payee". - 21 - all
r that the transactions purportedly generating the claimed amounts resulted either in any bona fide indebtedness or in any enforceable and bona fide obligation to pay compensation for use or forbearance of money on indebtedness within the meaning of I.R.C. Section 163. Furthermore, if it is established that any portion of the above disallowed "interest" is a properly 10 In some instances, respondent's notices of deficiency listed specific Kersting corporations under "Purported Payee". - 21 - all
The Court of Appeals for the Second Circuit declined to accept the taxpayers' argument and held that in order for an interest deduction to be valid under section 163, the underlying transaction must have economic substance.
r that the transactions purportedly generating the claimed amounts resulted either in any bona fide indebtedness or in any enforceable and bona fide obligation to pay compensation for use or forbearance of money on indebtedness within the meaning of I.R.C. Section 163. Furthermore, if it is established that any portion of the above disallowed "interest" is a properly 10 In some instances, respondent's notices of deficiency listed specific Kersting corporations under "Purported Payee". - 21 - all
age interest relating to properties owned by Sandew. Petitioners contend that Sandew was bankrupt, and, as guarantors of Sandew's loans, petitioners were obligated to pay Sandew's interest expenses and, therefore, entitled to a deduction pursuant to section 163. Generally, a guarantor is not entitled to an interest expense deduction with respect to payments made in fulfillment of a mere guaranty obligation. See Hynes v. Commissioner, 74 T.C. 1266, 1287-1288 - 5 - (1980). The Court of Appeals for
r that the transactions purportedly generating the claimed amounts resulted either in any bona fide indebtedness or in any enforceable and bona fide obligation to pay compensation for use or forbearance of money on indebtedness within the meaning of I.R.C. Section 163. Furthermore, if it is established that any portion of the above disallowed "interest" is a properly 10 In some instances, respondent's notices of deficiency listed specific Kersting corporations under "Purported Payee". - 21 - all
Mortgage Interest Deductions Section 163 allows a deduction for certain qualified interest.
r that the transactions purportedly generating the claimed amounts resulted either in any bona fide indebtedness or in any enforceable and bona fide obligation to pay compensation for use or forbearance of money on indebtedness within the meaning of I.R.C. Section 163. Furthermore, if it is established that any portion of the above disallowed "interest" is a properly 10 In some instances, respondent's notices of deficiency listed specific Kersting corporations under "Purported Payee". - 21 - all
rovides that “There shall be allowed as a deduction all interest paid or accrued within the taxable year on indebtedness.” Court opinions have clearly established that a lack of economic substance may operate to bar interest deductions arising under section 163. See Knetsch v. United States, 364 U.S. 361 (1960); United States v. Wexler, supra; Goldstein v. Commissioner, 364 F.2d 734 (2d Cir. 1966), affg. 44 T.C. 284 (1965). Interest payments are not deductible if they arise from transactions “th
. Commissioner, 190 F.3d 791 (7th Cir. 1999), revg. in part T.C. Memo. 1998-92, the Court of Appeals for the Seventh Circuit sua sponte raised the issue of the degree of deference owed to temporary interpretive regulations issued by respondent under sec. 163 without notice and comment procedures. Because both parties assumed that Chevron deference applied in this circumstance, the court reserved judgment on whether a lesser degree of deference was appropriate. Prior to amendment in 1984, sec. 26
- 20 - Petitioner next argues that she is entitled to claim a deduction under section 163 of $1,250 for prepaid interest (points) that she paid in connection with the purchase of her house, and that she is entitled to amortize and deduct a portion of the remaining $1,250 payment of points as a rental expense on Schedule E.
Section 1.166-9(b), Income Tax Regs., further provides that neither section 163 nor section 165 will apply with respect to such a payment.
t the limitations of sec. 163(d) would apply to petitioners’ interest payments on the Branch property. Because of the manner in which the issue was posed by the parties and the limited scope of our inquiry, we must assume that respondent agrees that sec. 163 would not limit petitioners’ deduction if we decide the issue, as framed, in petitioners’ favor. - 7 - Respondent argues that the absence of a rental agreement between petitioners and the corporation is a factor that supports a finding that
st paid on the promissory note in the amounts of $7,249, $5,220, and $5,409, respectively. Respondent disallowed these deductions on the - 5 - grounds that they were neither business expenses under section 162 nor deductible interest expenses under section 163. OPINION Respondent contends that the interest payments on the promissory note are nondeductible personal expenses. The interest accrued on funds that were characterized in the promissory note as petitioner's "medical school tuition and ex
Section 163 generally allows the deduction of interest paid on indebtedness during the taxable year. Section 163(d)(1) limits the deduction for investment interest to the extent of net investment income. Investment interest means interest paid on indebtedness allocable to property held for investment. Sec. 163(d)(3)(A). Property held for investment
For example, section 163(h) provides that a taxpayer other than a corporation may not deduct personal interest.14 Sec. 163(h). Excluded from the definition of personal interest is investment interest. Sec. 163(h)(2)(B). 14 Sec. 163(h)(2) provides, in pertinent part, as follows: (2) Personal interest.--For purposes of this subsection, the
Generally, section 163 provides that interest on indebtedness is deductible by the taxpayer in the year it is paid.
For example, section 163(h) provides that a taxpayer other than a corporation may not deduct personal interest.14 Sec. 163(h). Excluded from the definition of personal interest is investment interest. Sec. 163(h)(2)(B). 14 Sec. 163(h)(2) provides, in pertinent part, as follows: (2) Personal interest.--For purposes of this subsection, the
- 11 - amount subject to the limitations of section 163(h)(3) and the provisions of section 1.163-8T, Temporary Income Tax Regs., 52 Fed. Reg. 24999 (July 2, 1987), to the extent applicable. Priv. Ltr. Rul. 89-28-010 (Apr. 6, 1989); see also Priv. Ltr. Rul. 90- 31-022 (May 7, 1990) (concluding that section 1041 does not apply to characterize interest expense on loan proceeds allocable to investment expenditures as personal interest for purposes of section 163(h)).
Petitioner argues that such amount, to the extent substantiated,6 should be allowed pursuant to section 163 as interest incurred in the conduct of a trade or business.
Petitioner theorizes that we must look to section 163 for the deduction, and in turn, the section 267 limitations would then apply.
years in question. Respondent allowed petitioners a full deduction for interest expenses identified from "investment sources" in the KPMG analysis, and a partial deduction for interest expenses identified from "personal sources", in accordance with section 163. Discussion We must decide whether respondent properly imputed dividends to petitioners in 1987 and 1988 under section 7872 where no evidence indicates that interest had accrued or was otherwise paid on the loans in those years. (Petitione
30 Deficiency 1987 $175,870 1988 17,909 1989 15,048 1990 187,808 1991 289,879 1992 15,402 The issue on which petitioner has moved for partial summary judgment is whether petitioner is entitled to deductions for interest pursuant to section 163 for taxable years ending September 30, 1990, through September 30, 1992.
Other provisions of section 163 limit such deductions.
ed approximately 70 days prior to the expiration of the normal 3-year period of limitations applicable to the assessment of Federal income taxes. Sec. 6501(a). - 4 - compensation for use or forbearance of money on indebtedness within the meaning of I.R.C. Section 163. Furthermore, if it is established that any portion of the above disallowed "interest" is a properly allowable deduction, it is further determined that such interest constitutes interest in investment indebtedness and deduction of s
1991 -- Claimed Investment Interest Expense Section 163 allows taxpayers a deduction for the payment of interest on indebtedness allocable to property held for investment.
tem, or any part thereof, are determined to be "section 38 property", as defined in section 48(a)(1), then petitioner is entitled to: (1) An ITC with respect to such section 38 property (or part thereof); (2) a 5-year depreciation schedule under section 168(b)(1) with respect to such section 38 property (or part thereof); and (3) a deduction under section 163 for interest accrued during the construction period with respect to such section 38 property (or part thereof).
The taxpayer argued that the economic substance doctrine did not apply to the deduction of interest payments pursuant to section 163 if the taxpayer's obligation to pay the interest is binding and enforceable.
385, the Internal Revenue Service (IRS) announced that for debt incurred to acquire an interest in a residence incident to divorce or legal separation, regulations will provide that, in general, such debt will be eligible to be treated as debt incurred in acquiring a residence for purposes of section 163, without regard to the treatment of the transaction under section 1041.
tem, or any part thereof, are determined to be "section 38 property", as defined in section 48(a)(1), then petitioner is entitled to: (1) An ITC with respect to such section 38 property (or part thereof); (2) a 5-year depreciation schedule under section 168(b)(1) with respect to such section 38 property (or part thereof); and (3) a deduction under section 163 for interest accrued during the construction period with respect to such section 38 property (or part thereof).
Petitioner theorizes that we must look to section 163 for the deduction, and in turn, the section 267 limitations would then apply.
Petitioners have not cited (and we are not aware of) any case in which a court disallowed interest deductions under section 163 and allowed them under section 212.
(2) Exceptions.--Paragraph (1) shall not apply to-- (A) Certain specific deductions--Any-- (i) deduction allowable under section 163 (relating to interest), (ii) deduction for amounts which are properly allocable to indebtedness and amortized over the term of such indebtedness, or (iii) deduction for dividends (continued...) - 4 - section 162(k) applies to the period in which the costs and fees at issue in this case were paid or incurred and changes the tax treatmen
We so state because we have consistently been reluctant to conclude that Congress overruled existing case law when the statutory language does not compel such a conclusion and Congress has not otherwise expressly indicated that such a result should ensue.
rantee fees paid on the commercial paper "did not exceed the amounts that would be charged by an unrelated party, those fees were reasonable for purposes of section 162(a) and consistent with arm's-length amounts for purposes of section 482." Respondent contends that there was no genuine indebtedness underlying the interest payment, as required by section 163, and, therefore, the transactions were shams.
's business. Sec. 280A(c)(1); Commissioner v. Soliman, 506 U.S. 168 (1993); Cao v. 9 Under sec. 280A(b), deductions which are otherwise allowable without regard to any connection with a trade or business include the deduction for: (1) Interest under sec. 163, subject to the sec. 163(h)(1) personal interest restriction, (2) real estate taxes under sec. 164, and (3) casualty losses under sec. 165. - 24 - Commissioner, T.C. Memo. 1994-60, affd. without published opinion 78 F.3d 594 (9th Cir. 1996).
For the years 1979, 1980, and 1981 petitioner claimed interest expenses paid to the Mirhosseini family in the amounts of $15,000, $44,879, and $36,000, respectively. On or about September 10, 1979, three members of the Mirhosseini family each - 233 - lent petitioner $80,000. He agreed to invest the total sum of $240,000 in his operating
interest deduction was properly taken for 1987. The deduction in issue stems from the $13,167.96 interest payment Betsy made to Markette. We agree with respondent’s conclusion. - 149 - For 1987, section 16336 allowed a deduction, subject to the 36 Sec. 163 provides, in pertinent part, as follows: SEC. 163. INTEREST. (a) General Rule.--There shall be allowed as a deduction all interest paid or accrued within the taxable year on indebtedness. * * * * * * * (d) Limitation on Investment Interest.--
For the years 1979, 1980, and 1981 petitioner claimed interest expenses paid to the Mirhosseini family in the amounts of $15,000, $44,879, and $36,000, respectively. On or about September 10, 1979, three members of the Mirhosseini family each - 233 - lent petitioner $80,000. He agreed to invest the total sum of $240,000 in his operating
3(b) which provides in pertinent part that in the case of an activity which is not for profit, the deductions allowable are those allowable "without regard to whether or not such activity is engaged in for profit." Respondent has agreed that petitioner substantiated $1,849 of mortgage interest paid in 1991, and that this amount is deductible under section 163 without regard to whether the activity is engaged in for profit and is to be added to his itemized deductions.
rantee fees paid on the commercial paper "did not exceed the amounts that would be charged by an unrelated party, those fees were reasonable for purposes of section 162(a) and consistent with arm's-length amounts for purposes of section 482." Respondent contends that there was no genuine indebtedness underlying the interest payment, as required by section 163, and, therefore, the transactions were shams.
rantee fees paid on the commercial paper "did not exceed the amounts that would be charged by an unrelated party, those fees were reasonable for purposes of section 162(a) and consistent with arm's-length amounts for purposes of section 482." Respondent contends that there was no genuine indebtedness underlying the interest payment, as required by section 163, and, therefore, the transactions were shams.
rantee fees paid on the commercial paper "did not exceed the amounts that would be charged by an unrelated party, those fees were reasonable for purposes of section 162(a) and consistent with arm's-length amounts for purposes of section 482." Respondent contends that there was no genuine indebtedness underlying the interest payment, as required by section 163, and, therefore, the transactions were shams.
The second action is a 1990 proposal of the Senate Finance Committee to amend section 163 by eliminating the deduction for corporate taxpayers of interest on income tax deficiencies.
— Any— (i) deduction allowable under section 163 (relating to interest), (ii) deduction for amounts which are properly allocable to indebtedness and amortized over the term of such indebtedness, or (iii) deduction for dividends paid (within the meaning of section 561).
tgage interest. It provides no guidance in determining whether the interest is deductible on Schedule A or Schedule C. As mentioned above, mortgage interest expense is not disallowed by section 280A and may be deducted as an itemized deduction under section 163. See sec. 280A(b). Further, if any part of the interest is an ordinary and necessary business expense within the meaning of section 162, it may be deducted from gross income. See sec. 62(a)(1). Otherwise, at least as relevant herein, mort
the bond or note secured by such mortgage. Sec. 1.163-1(b), Income Tax Regs. However, only interest paid or accrued on a mortgage on property for the period after the taxpayer becomes the legal or equitable owner of the property is deductible under section 163. Hyde v. Commissioner, 64 T.C. 300, 306 (1975) (interest accruing before, but paid by the taxpayer, must be capitalized). We are unconvinced that Good Shepherd either made any payments of interest during the years in question or had any g
the bond or note secured by such mortgage. Sec. 1.163-1(b), Income Tax Regs. However, only interest paid or accrued on a mortgage on property for the period after the taxpayer becomes the legal or equitable owner of the property is deductible under section 163. Hyde v. Commissioner, 64 T.C. 300, 306 (1975) (interest accruing before, but paid by the taxpayer, must be capitalized). We are unconvinced that Good Shepherd either made any payments of interest during the years in question or had any g
tgage interest. It provides no guidance in determining whether the interest is deductible on Schedule A or Schedule C. As mentioned above, mortgage interest expense is not disallowed by section 280A and may be deducted as an itemized deduction under section 163. See sec. 280A(b). Further, if any part of the interest is an ordinary and necessary business expense within the meaning of section 162, it may be deducted from gross income. See sec. 62(a)(1). Otherwise, at least as relevant herein, mort
Where mortgaged property is jointly owned and the co-owners are jointly liable on the mortgage each owner is entitled to a deduction for the mortgage interest that he actually pays out of his own funds. Castaneda-Benitez v. Commissioner, T.C. Memo. 1981-157. Section 6001 and the regulations promulgated thereunder require a taxpayer to mai
ues for decision are: (1) Whether certain deductions taken by petitioner in 1988 are prohibited by section 162(k); and (2) whether certain expenses incurred by petitioner in 1988 constitute a fee for services as opposed to interest deductible under section 163. FINDINGS OF FACT Some of the facts have been stipulated and are so found. The stipulation of facts, first and second supplemental stipulations of facts, and attached exhibits are incorporated herein by this reference. During 1988, petitio