The Internal Revenue Code does not allow deductions for “personal interest.” Nonetheless, qualified residence interest, which includes interest on acquisition indebtedness and home equity indebtedness on a qualified residence, is deductible. Generally, acquisition indebtedness is deductible only on the first $1 million of acquisition indebtedness. Home equity indebtedness is generally deductible on $100,000 of home equity indebtedness.
What happens if a taxpayer borrows $1.1 million to buy a qualified residence? Can the taxpayer get interest deductions on $1 million of acquisition indebtedness, AND interest deductions on another $100,000 of the acquisition debt? Or is the full $1.1 million clearly acquisition indebtedness only, thus qualifying only $1 million of the debt for deductible interest?
In Pau, TC Memo 1997-43 and Catalano, TC Memo 2000-82 , the Tax Court limited interest deductions in this context to the acquisition indebtedness amount only of $1 million. Interestingly, the IRS has now reversed course and in a Chief Counsel Advice is now allowing interest deductions on $1.1 million - $1 million for acquisition indebtedness and another $100,000 as home equity indebtedness. Its a rare day that the IRS goes against court precedent to provide a favorable interpretation for taxpayers, instead of the IRS.
Chief Counsel Advice 200940030