The Tax Court in Brief – January 23rd – January 27th, 2023
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Tax Litigation: The Week of January 23rd, 2022, through January 27th, 2023
- Lim v. Comm’r, T.C. Memo. 2023-11| January 23, 2023 | Lauber, J. | Dkt. No. 14015-20
- Freman v. Comm’r, T.C. Memo. 2023-10| January 23, 2023 |Jones, J. | Dkt. No. 8895-20
- Belton v. Comm’r, T.C. Memo. 2023-13| January 24, 2023 |Toro, J. | Dkt. No. 22438-19P
- Adams v. Comm’r, 160 T.C. No. 1| January 24, 2023 | Toro, J. | Dkt. No. 1527-21P
- Mulu v. Comm’r, T.C. Summary Opinion 2023-2| January 25, 2023 | Leyden, J. | Dkt. No. 12975-21S
- Aragoni v. Comm’r, T.C. Summary Opinion 2023-3| January 25, 2023 | Panuthos, J. | Dkt. No. 20914-21S
- Johnson v. Comm’r, 160 T.C. No. 2| January 25, 2023 |Nega, J. | Dkt. No. (Consolidated) 19973-18, 19975-18, 19978-18, 20001-18
Shilgevorkyan v. Comm’r, T.C. Memo. 2023-12| January 23, 2023 | Ashford, J. | Dkt. No. 9247-15
Summary: This is a deficiency case involving taxpayer Hrach Shilgevorkyan (Petitioner) and the IRS’s disallowance of a mortgage interest deduction for tax year 2012. In 2005 Edvard, Petitioner’s brother, purchased the property in issue in Paradise Valley, Arizona for $1,525,000, making a $392,896 down-payment and obtaining a $1,143,750 bank loan from Wells Fargo. Edvard and his wife, Lusine, were the borrowers. Edvard, Lusine, and Artur (Petitioner’s other brother) took out a $1,200,000 construction loan. Both loans were secured by the Paradise Valley property. The construction loan funds were used to construct a house and a separate guest house on the property. In 2006 and again in 2008, Edvard, Lusine, and Artur refinanced with Wells Fargo. The disclosures and deed of trust contained representations and prohibitions of transfers made without Wells Fargo’s consent, and the deed of trust further stated that the Paradise Valley property would be the borrower’s principal residence for at least one year unless the lender agreed. Artur executed a quitclaim deed in 2010, which conveyed all his interest in the property to Petitioner. No request was made to Wells Fargo to approve the conveyance. Petitioner did not pay Artur in exchange for the quitclaim deed. During 2012 Petitioner made no payments to Wells Fargo related to the loan secured by the property. Wells Fargo did not issue Petitioner a Form 1098, Mortgage Interest Statement, for 2012. With limited exceptions, Petitioner did not reference the Paradise Valley property as being his place of residence or address, even though he lived in the guest house for a time. On his 2012 federal income tax return Petitioner deducted $66,354 for mortgage interest paid related to the Paradise Valley property. This deduction was for one-half the total mortgage interest paid in 2012 on the Paradise Valley loan as reported by Wells Fargo on the Form 1098 that was issued to Edvard and Lusine.
Key Issues: Whether the IRS’s disallowance of the mortgage interest deduction was appropriate?
Primary Holdings: Yes. Petitioner did not prove that the indebtedness on the Paradise Valley property was his obligation (even though the Tax Court made an assumption that it was), (2) Petitioner did not show ownership (legal or equitable) in the property, and the quitclaim deed did not, under state law, convey title to Petitioner, and (3) the residence is the taxpayer’s qualified residence, and (3) Petitioner failed to show that the property was his “qualified residence.”
Key Points of Law:
Burden of Proof. In general, the IRS’s determinations set forth in a notice of deficiency are presumed correct, and the taxpayer bears the burden of proving otherwise. Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933). If the taxpayer produces credible evidence with respect to any factual issue relevant to ascertaining his federal income tax liability and meets certain other requirements, the burden of proof shifts from the taxpayer to the IRS as to that factual issue. § 7491(a)(1) and (2). That burden-shifting mechanism is not applicable in this case.
Section 163 Mortgage Interest Deduction. Tax deductions are a matter of legislative grace, and the taxpayer bears the burden of proving entitlement to any deduction claimed. Rule 142(a); INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992). This burden requires the taxpayer to demonstrate that the claimed deductions are allowable pursuant to some statutory provision and to substantiate the expenses giving rise to the claimed deductions by maintaining and producing adequate records that enable the IRS to determine the taxpayer’s correct liability. 26 U.S.C. § 6001; Higbee v. Commissioner, 116 T.C. 438, 440 (2001); Hradesky v. Commissioner, 65 T.C. 87, 89–90 (1975), aff’d per curiam, 540 F.2d 821 (5th Cir. 1976).
Section 163(a) allows a deduction for all interest paid or accrued within the taxable year on indebtedness. Section 163(h)(1), however, provides that in the case of a taxpayer other than a corporation (i.e., an individual) no deduction is allowed for personal interest paid or accrued during the taxable year. Qualified residence interest is excluded from the definition of personal interest and so is deductible under section 163(a). See 26 U.S.C. § 163(h)(2)(D).
Elements Required. A taxpayer 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 the taxpayer’s obligation, (2) the taxpayer must either be the legal or equitable owner of the property subject to the mortgage, and (3) the residence is the taxpayer’s qualified residence. See Treas. Reg. § 1.163-1(b).
Qualified Residence Interest. The term “qualified residence interest” means any interest paid or accrued during the taxable year on either acquisition or home equity indebtedness with respect to any qualified residence of the taxpayer. Id. at § 163(h)(3)(A). A taxpayer’s qualified residence is his or her principal residence (within the meaning of section 121) and one other residence of the taxpayer which is selected by the taxpayer and is used by the taxpayer as a residence (within the meaning of section 280A(d)(1)). Id. at § 163(h)(4)(A). The determination of whether any property is a qualified residence of the taxpayer shall be made as of the time the interest is accrued. Id. at § 163(h)(3)(A) (flush language).
Acquisition Indebtedness. Acquisition indebtedness is any indebtedness which is (1) incurred in acquiring, constructing, or substantially improving any qualified residence of the taxpayer and (2) secured by such residence. Id. at § 163(h)(3)(B)(i). For any period, the aggregate amount of acquisition indebtedness shall not exceed $1 million. Id. at § 163(h)(3)(B)(ii). Acquisition indebtedness also includes any indebtedness secured by such residence resulting from the refinancing of acquisition indebtedness, but only to the extent the amount of the indebtedness resulting from such refinancing does not exceed the amount of the refinanced indebtedness. Id. at § 163(h)(3)(B)(i) (flush language).
Jointly-Owned Property. Where a 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. Jolson v. Commissioner, 3 T.C. 1184, 1186 (1944). The indebtedness generally must be an obligation of the taxpayer claiming the deduction, not the obligation of another. Golder v. Commissioner, 604 F.2d 34, 35 (9th Cir. 1979), aff’g T.C. Memo. 1976-150. Interest paid by the taxpayer on a real estate mortgage 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. Treas. Reg. § 1.163-1(b). State law determines the nature of property rights, such as legal or equitable ownership, while federal law determines the appropriate federal tax consequences of those rights. See United States v. Nat’l Bank of Com., 472 U.S. 713, 722 (1985); Blanche v. Commissioner, T.C. Memo. 2001-63, aff’d, 33 F. App’x 704 (5th Cir. 2002).
Insights: Deductions are a matter of legislative grace. To be entitled to a mortgage interest deduction: (1) the indebtedness must be the taxpayer’s obligation, (2) the taxpayer must either be the legal or equitable owner of the property subject to the mortgage, and (3) the residence is the taxpayer’s qualified residence. See Treas. Reg. § 1.163-1(b). In determining a taxpayer’s “qualified residence,” the Tax Court may review all representations made by the taxpayer as to his or her residence address, including the address used on loan forms, tax returns, and other official state and federal filings or submissions.