Exhibit 7.2:
IRC § 469(j)(7) -
Interest On Rental
Residence
ISSUE: Is
interest expense on
Schedule E
deductible under IRC
§ 469(j)(7)? The IRC
§ 469(j)(7) and Reg.
§ 1.163-8T(m)(3)
provide that passive
activity losses will
be computed without
regard to qualified
residence interest
as defined in IRC §
163. A "qualified
residence" as
defined by IRC §
163(h)(5)(A)(i) is
either a principal
residence or a
second residence.
NOTE: Qualified
residence interest
belongs on Schedule
A and is therefore
subject to the
itemized deduction
limitations.
_____ Verify that
property is
taxpayer's
"principal
residence".
Reg. §
1.163-10T(p)(2)
indicates that
principal residence
means principal
residence as defined
by IRC §1034. The
taxpayer cannot have
more than one
principal residence
at any one time. In
Stolk V. Comm., 40
TC 345 , the
taxpayer moved out
of his principal
residence two years
prior to its sale,
and the Court held
that the property
did not qualify as
his principal
residence.
Similarly, in
Friedman v. Comm.,
T.C. Memo 1982-178,
the Court held that
a residence used by
the taxpayer only
during the summer
months cannot
qualify as a
principal residence.
If property is
taxpayer's principal
residence, skip the
next
step.
If it is not the
taxpayer's principal
residence, continue
on.
_____ Verify that
property is
taxpayer's "second
residence". If
property is rented,
Reg. §
1.163-10T(p)(3)(ii)
states that it
qualifies as a
residence only if
taxpayer used it
personally for the
greater of 14 days
or 10 percent of
days rented (IRC §
280A(d)).
QUESTION: How
many days did you
spend at the rental
property during the
year?
NOTE: In
virtually all cases,
box 2 on Schedule E
has been checked NO,
indicating that the
taxpayer fails the
requirements of IRC
§ 280A(d).
Therefore, the
property does not
qualify as a second
residence. If box 2
is YES and taxpayer
spends more than 14
days, losses are
limited IRC § 280A,
i.e. expenses
deductible up to
rental income.
_____ Verify via
review of bank
statement and/or
cancelled check that
interest was
actually paid in
year deducted.
If taxpayer fails
qualified residence
test OR cannot
verify interest,
disallow losses. If
he passes, go to
next step.
_____ Verify that
interest expense
qualifying under IRC
§ 469(j)(7), i.e.
qualified residence
interest, has been
properly
reflected on
Schedule A as an
itemized deduction.
Some taxpayers have
moved interest to
another column on
Schedule E, avoiding
the itemized
deduction
limitations.
LAW: Qualified
residential interest
is claimed as an
itemized deduction
from adjusted gross
income. The IRC
§161 provides that
deductions permitted
by subtitle A, Ch.
1, Subchapter B,
Part VI (itemized
deductions),
including interest
deductions under
163, are taken in
computing taxable
income under
63. Therefore, it
is improper for
qualified residence
interest to be
claimed on Schedule
E as a deduction
from AGI.
CONCLUSION:
Under IRC §
469(j)(7) and §
163(h)(5)(A)(i),
taxpayer has/has not
(circle one)
verified the
deductibility of
qualified residence
interest from
property rented on
Schedule E. OR
A
personal residence
is subject to the
itemized deduction
limitations on
Schedule A,
including the 3
percent phaseout for
high income
taxpayers. The IRC
§ 469 does not
override other IRC
sections. It is
merely one of
several IRC
sections, which
limit losses on a
tax return. While §
469(j)(7) excepts
qualified residence
interest from the
passive loss
limitations, nowhere
does the IRC,
Regulations. or
legislative history
state or imply that
home mortgage
interest is not
subject to the
itemized deduction
limitations. To the
contrary, Reg.
§1.469-1T(d)
specifically
provides that the
application of IRC §
469 does not affect
the treatment of
items under any
provision of the IRC
other than IRC §
469. In other words,
the mere fact that
IRC § 469 permits
deductibility does
not mean that other
IRC sections may not
limit the interest
expense. Qualified
residential interest
is claimed as an
itemized deduction
from adjusted gross
income. The IRC
§161 provides that
deductions permitted
by subtitle A, Ch.
1, Subchapter B,
Part VI (itemized
deductions),
including interest
deductions under
163, are taken in
computing taxable
income under
63. Therefore, it
is improper for
qualified residence
interest to be
claimed on Schedule
E as a deduction
from AGI. There is
nothing in the
language of the IRC,
Regulations or
committee reports to
suggest that
personal residence
interest from a
rented residence
should be excepted
from itemized
deductions.
