IRS RULES FAVORABLY ON RESIDENCE INTEREST DEDUCTIONS

Generally, interest paid by a taxpayer on personal items is not deductible. However, the Code allows an interest deduction for "acquisition indebtedness" for a qualified residence of a taxpayer for up to $1 million of indebtedness. A taxpayer may also deduct interest on up to $100,000 of "home equity indebtedness."

If a taxpayer incurs a mortgage debt on a qualified residence of over $1 million when he buys the residence, clearly he can deduct interest on the first million dollars of debt. Can he use the "home equity indebtedness" provisions to obtain an interest deduction on the first $100,000 over the first million dollars of debt? Until now, the answer was no, at least according to 2 Tax Court Memo decisions and a 2009 Chief Council Advice.

Happily for taxpayers (or at least for those that can afford to take on mortgages in excess of $1 million), the IRS has reversed its position and will now allow the use of the "home equity indebtedness" provisions for interest on the first $100,000 of acquisition indebtedness in excess of $1 million already allowed. The IRS based its decision on the fact that there is no provision in the Code that restricts "home equity indebtedness" to indebtedness not incurred in acquiring, constructing, or substantially improving the residence.

It is not often that the IRS reverses both itself and the Tax Court in a manner favorable to taxpayers. This is something of an early holiday gift for sure.

For any taxpayers that are eligible for additional interest deductions under these rules for prior open tax years, they should consider filing an amended tax return to obtain the benefit of this ruling.

Revenue Ruling 2010-25

FRAUDULENT HOMESTEAD CONVEYANCE AND INCOME TAXES

Florida’s Uniform Fraudulent Transfer Act will allow a creditor to reach an asset transferred from a debtor to a third party if the transfer is found to constitute a fraudulent transfer. However, Fla.Stats. §726.102(2)(b) will exempt transfers of assets that are generally exempt from creditors under nonbankruptcy law from the fraudulent conveyance rules.

In Scott E. Rubenstein et al. v. Comm., an insolvent father transferred his exempt homestead to his son. The IRS sought to set aside the homestead transfer as a fraudulent conveyance so as to assist in collecting the father’s income tax liabilities. The son argued that under the above Florida statute, the homestead was an exempt asset and thus the fraudulent conveyance rules could not apply to it.

That may be true for other creditors, but not the U.S. The IRS is not bound by the exempt status under Florida law as to homestead property in collection matters, and thus as to the U.S. the homestead was NOT generally exempt from creditors under nonbankruptcy law. As such, it was likewise not exempt from the application of the Fraudulent Transfer Act.

Scott E. Rubenstein et al. v. Comm., 134 TC No. 13 (6/7/10)

NO ONE EVER SAID THE CODE IS A TWO WAY STREET

On May 6, the stock market fell victim to the “flash crash.” In a short period of time, the market took a major dive, and then quickly recovered. Experts are still looking for what triggered the unusual movement.

Many taxpayers who had standing stop-loss orders on their securities had their securities sold for a gain or loss due to the large percentage swing that occurred.

Under the wash sale rules, those taxpayers who repurchased the same securities within 30 days cannot deduct any losses from such sales – instead, the losses will be figured into their basis on the subsequent sale of the securities.

Essentially arguing that since losses from the flash crash are deferred, some taxpayers sought a special dispensation from the IRS Commissioner that in regard to securities that were sold for a gain, the taxpayers would be allowed to repurchase their sold securities and avoid having to recognize their gains.

Not surprisingly, the Commissioner declined, per their being no authority in the Internal Revenue Code for such a deferral. Beyond the lack of specific authority, additionally there is no constitutional or statutory requirement that gains and losses be treated in the same manner under law. Indeed, the Code is rife with provisions that limit the use of losses (e.g, the $3,000 capital loss limitation, passive loss limitations, etc.) that have no corollary deferral of gain. The Code is not the place to go looking for fair and balanced provisions that impact the taxpayers and the government in equal measure.

Information Letter 2010-0188