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IRS's Own Evidence Supports Taxpayer's Mortgage Interest Deductions; Home Office Deduction Denied

(Parker Tax Publishing December 2016)

The Tax Court determined that a taxpayer was entitled to a mortgage interest deduction for his residence, but denied his home office expense deductions. The court concluded that a Form 1098 obtained by the IRS from the mortgage company was sufficient evidence that the taxpayer paid the interest, despite the fact that the mortgage company had also issued a Form 1099-C in the same year, reporting that a substantial amount of interest on the debt had been forgiven. Alexander v. Comm'r, T.C. Memo. 2016-214.

Malcom Alexander owned two houses during 2010. The first house was in Washington, D.C., and the second was his principal residence in Gaithersburg, Maryland (Gaithersburg house). According to Alexander, he purchased the Gaithersburg house primarily for use in his multilevel network marketing business, and three of its 11 rooms - a first-floor office, a second-floor office, and a "presentation room" - regularly and exclusively for his business.

In 2010 Alexander paid to American Star Financial, Inc. (American Star), mortgage interest of $57,220 in connection with the Gaithersburg house. Also in 2010, American Star issued him a Form 1099-C, Cancellation of Debt, reporting that the company canceled $100,665 of debt relating to the Gaithersburg house, including $52,746 of interest.

On his 2010 income tax return, Alexander claimed a $57,220 deduction for the interest paid on the Gaithersburg house, and claimed he was entitled to a home office expense deduction for the use of 27.27 percent of the house. The IRS audited the return, and denied the deductions.

Code Sec. 163(h) generally allows taxpayers to deduct "qualified residence interest," which includes amounts paid or accrued during the taxable year on acquisition indebtedness (such as a mortgage).

Under Code Sec. 280A(c)(1), taxpayers can deduct expenses attributable to a home office if the expenses are allocable to a portion of the dwelling unit which is exclusively used on a regular basis as the principal place of business for the taxpayer's trade or business.

The Tax Court stated that at trial Alexander testified credibly that he paid $57,220 in mortgage interest to American Star in 2010, noting that a Form 1098, Mortgage Interest Statement, the IRS subpoenaed from the company showed that it received $57,220 of mortgage interest from Alexander in 2010 in connection with the Gaithersburg house.

The IRS argued that American Star canceled Alexander's mortgage interest for 2010 and therefore he did not pay the interest reported as received by American Star on the Form 1098. The court stated it was not persuaded by the IRS's argument for several reasons. First, the court said, the IRS presented no evidence that the reported cancellation of indebtedness was connected to the interest payments American Star reported having received. Second, the court noted the amount of interest reported as canceled on the Form 1099-C ($52,746) was not the same as the amount of interest reported as received by American Star on the Form 1098 ($57,220). Furthermore, the court observed, the IRS conceded before trial that Alexander wasn't liable for the cancellation of indebtedness income reported on the Form 1099-C. Accordingly, the court held that Alexander was entitled to his claimed $57,220 mortgage interest deduction.

With regard to Alexander's claimed home office expense deductions, the court noted that in order to substantiate that he used 3 of 11 rooms (i.e., 27.27 percent) of the Gaithersburg house regularly and exclusively for business purposes, Alexander offered into evidence copies of photographs depicting rooms, folding chairs, and social gatherings. However, the court stated, the copies of photographs did not establish whether the rooms were used regularly and exclusively for the network marketing business. In addition, the court stated that even if Alexander established that he used certain rooms regularly and exclusively for business purposes, he provided no testimony or documentation concerning the size of the house and rooms which would allow it to properly allocate costs. Accordingly, the court sustained the IRS's disallowance of a home office expense deduction.

For a discussion of mortgage interest deductions, see Parker Tax ¶83,515. For a discussion of home office deductions, see Parker Tax ¶85,505.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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