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Mortgage Interest Ruling, New Safe Harbor, Tax Avoidance Fails

Berdon Tax Team 09.08.2015 | eVisor

FEDERAL TAX

Favorable Decision on the Deduction of Mortgage Interest

The Ninth Circuit Court of Appeals recently allowed two unmarried co-owners of a property to apply the mortgage interest deduction on a per-taxpayer basis rather than on a per-property basis - enabling each to take the full deduction and essentially realize twice the benefit  This interpretation is not shared by the Internal Revenue Service (IRS) or the Tax Court. Going forward, it remains uncertain whether the position of the Ninth Circuit will be sustained in future litigation in the face of the position held by the IRS and Tax Court.  Taxpayers should take a watchful approach.

In Voss v. Commissioner,1 the co-owners asserted that they were entitled to their own limitation for the same property. The IRS took the position that they had to share the limitation. The Ninth Circuit sided with the taxpayers and held that the limitation is on a per-taxpayer basis.

Generally, no deduction is allowed for personal interest.  However, a deduction is allowed for interest on a mortgage on the taxpayer's principal residence and a second home. The home mortgage deduction is limited to the interest on $1.1 million of a taxpayer's mortgage or $550 thousand for married taxpayers filing separately.  This dollar limitation is not subject to inflation adjustment.

The Tax Court supported the IRS (before being overrulled by the appeals court) and held that the limit is on a per-property basis.  The Court of Appeals opinion will only apply to those taxpayers living in the Ninth Circuit - the Pacific Coast - while this Tax Court decision will continue to apply to those living outside the Ninth Circuit.  However, the Tax Court is likely to review the position next time it is litigated and determine whether it will adopt the position of the Ninth Circuit.

1 Bruce H. Voss, Petitioner v. Commissioner of Internal Revenue, United State Court of Appeals, Ninth Circuit, Decided August 7, 2015

Questions? Contact your Berdon advisor

New Safe Harbor for Ratable Service Contracts

Accrual method taxpayers are permitted to deduct the costs of services as they are provided.  However, current rules do not offer guidance as to how to determine when the services are provided when the taxpayer has entered into a service contract that spans multiple taxable years. The IRS has now provided a safe harbor method for ratable service contracts. 1

Under the safe harbor method, the services are treated as provided ratably over the term of the service contract. To qualify for the method, (i) the service contract must provide for similar services on a regular basis (e.g., weekly or monthly), (ii) each occurrence of service must provide independent value, and (iii) the term of the contract must not exceed 12 months (excluding renewals).  Under these terms, for example, a contract to provide daily janitorial services for twelve months would qualify.

The new safe harbor is effective for taxable years ending on or after July 30, 2015 (e.g., the 2015 calendar year). Existing taxpayers who would like to change the treatment of ratable service contracts to conform to the safe harbor will need to apply for a change in accounting method on Form 3115. The change is automatic and will not require the payment of a user fee.

1 Rev Proc. 2015-39

Questions? Contact your Berdon advisor.

NONPROFIT

Foundation's Aggressive Estate Tax Avoidance Strategy Shot Down

The title of the foundation was an attention-getter: "Educational Assistance Foundation for the Descendants of Hungarian Immigrants in the Performing Arts, Inc." Set up by the estate of a wealthy individual, the foundation was an attempt to eliminate any estate tax, but it went too far.1

At first, the IRS approved the foundation's application for tax-exempt status. However, the scholarships awarded by the foundation went to direct descendants of the deceased individual. This raised eyebrows at the IRS which challenged the tax exempt status of the foundation. The foundation argued that the scholarships were open to all eligible descendants of Hungarian immigrants. However, the foundation never made any attempt to advertise their availability to the general public.

The IRS revoked the foundation's tax exempt status because it did not operate exclusively for an exempt purpose and instead served private interests. The District Court supported the IRS noting that the foundation operated in a manner that benefitted one family which precluded it from having tax-exempt status.

1 Educational Assistance Foundation for the Descendants of Hungarian Immigrants in the Performing Arts, Inc. Plaintiff, v. United State of America, Defendant. United State District Court for the District of Columbia.

Questions? Contact your Berdon advisor or Saul Brenner, CPA, J.D., LL.M.  at 212.331.7630 | sbrenner@berdonllp.com

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