Deficiency For Disallowed Mortgage Interest Deduction; Qualified Residence Interest

Shilgevorkyan v. Comm’r, T.C. Memo. 2023-12| January 23, 2023 | Ashford, J. | Dkt. No. 9247-15

Summary: This is a deficiency case involving taxpayer Hrach Shilgevorkyan (Petitioner) and the IRS’s disallowance of a mortgage interest deduction for tax year 2012. In 2005 Edvard, Petitioner’s brother, purchased the property in issue in Paradise Valley, Arizona for $1,525,000, making a $392,896 down-payment and obtaining a $1,143,750 bank loan from Wells Fargo. Edvard and his wife, Lusine, were the borrowers. Edvard, Lusine, and Artur (Petitioner’s other brother) took out a $1,200,000 construction loan. Both loans were secured by the Paradise Valley property. The construction loan funds were used to construct a house and a separate guest house on the property. In 2006 and again in 2008, Edvard, Lusine, and Artur refinanced with Wells Fargo. The disclosures and deed of trust contained representations and prohibitions of transfers made without Wells Fargo’s consent, and the deed of trust further stated that the Paradise Valley property would be the borrower’s principal residence for at least one year unless the lender agreed. Artur executed a quitclaim deed in 2010, which conveyed all his interest in the property to Petitioner. No request was made to Wells Fargo to approve the conveyance. Petitioner did not pay Artur in exchange for the quitclaim deed. During 2012 Petitioner made no payments to Wells Fargo related to the loan secured by the property. Wells Fargo did not issue Petitioner a Form 1098, Mortgage Interest Statement, for 2012. With limited exceptions, Petitioner did not reference the Paradise Valley property as being his place of residence or address, even though he lived in the guest house for a time. On his 2012 federal income tax return Petitioner deducted $66,354 for mortgage interest paid related to the Paradise Valley property. This deduction was for one-half the total mortgage interest paid in 2012 on the Paradise Valley loan as reported by Wells Fargo on the Form 1098 that was issued to Edvard and Lusine.

Key Issues: Whether the IRS’s disallowance of the mortgage interest deduction was appropriate?

Primary Holdings: Yes. Petitioner did not prove that the indebtedness on the Paradise Valley property was his obligation (even though the Tax Court made an assumption that it was), (2) Petitioner did not show ownership (legal or equitable) in the property, and the quitclaim deed did not, under state law, convey title to Petitioner, and (3) the residence is the taxpayer’s qualified residence, and (3) Petitioner failed to show that the property was his “qualified residence.”

Key Points of Law:

Burden of Proof. In general, the IRS’s determinations set forth in a notice of deficiency are presumed correct, and the taxpayer bears the burden of proving otherwise. Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933). If the taxpayer produces credible evidence with respect to any factual issue relevant to ascertaining his federal income tax liability and meets certain other requirements, the burden of proof shifts from the taxpayer to the IRS as to that factual issue. § 7491(a)(1) and (2). That burden-shifting mechanism is not applicable in this case.
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The New York Times Editorial Board has written an editorial condemning tax breaks, which is justified, in part. They point out:

Tax breaks work like spending. Giving a deduction for certain activities, like homeownership or retirement savings, is the same as writing a government check to subsidize those activities. Functionally, they mimic entitlements. Like Medicare, Medicaid and Social Security, they are available, year in and year out, in full, to all who qualify. Yet in budget talks, Republicans ignore tax entitlements, which flow mostly to high-income taxpayers, while pushing to cut Medicare, Medicaid and Social Security.

While they point out that the deduction for homeownership is the same as writing a government check they go on and only point out the special deductions/entitlements they feel are the ones the rich take advantage of:

CARRIED INTEREST.   This loophole lets private equity partners pay tax on most of their income at a top rate of 20 percent, versus a top rate of 39.6 percent for other high-income professionals. It drains the Treasury of $13.4 billion a decade, and should be closed, along with a shelter recently enacted in Puerto Rico that would help shield the income of individuals whose taxes would rise if the carried-interest tax break was eliminated.

NINE-FIGURE I.R.A.’S.   Remember Mitt Romney’s $100 million I.R.A? Private equity partners apparently build up vast tax-deferred accounts by claiming that the equity interests transferred to such accounts from, say, their firms’ buyout targets are not worth much. No one knows how much tax is avoided this way. What is known is that I.R.A.’s are meant to help build retirement nest eggs, not to help amass huge estates to pass on to heirs.

‘LIKE KIND’ EXCHANGES.   As reported in The Times by David Kocieniewski, this tax break was enacted some 90 years ago to help farmers sell land and horses without owing tax, as long as they used the proceeds to buy new farm assets. Today, it is used by wealthy individuals and big companies to avoid tax on the sale of art, vacation homes, rental properties, oil wells, commercial real estate and thoroughbred horses, among other transactions. Government estimates say this costs about $3 billion a year, but industry data suggest the amount could be far higher.

While these entitlements, which can be abused egregiously,  they are not the only ones. What Congress really needs to do is discard the entire tax code except for §61 which defines income as:

Except as otherwise provided in this subtitle, gross income means all income from whatever source derived …

Starting with that clean slate they should only allow exceptions for those exceptions which are willfully, intelligently and fully understood when put in place. No passing them so we can read the bill later.

These exceptions to income should be subject to hard and fast sunset provisions with the continuing of the exceptions only after detailed review and assessment that the purpose for which it was provided still is valid.

The tax code should not be used for social policy reasons. Examples are numerous but some of them are:

1.  Education Credits – to promote higher education for a certain group of citizens … discrimination to “fix” discrimination.

2.  Earned Income Credit – the largest area of fraudulent returns.

3.  Child tax credits … paying people who cannot afford to have children to have children.

4.  Mortgage Interest Deduction … started with the tax code of 1952 to help enable the returning veterans buy homes … something Congress deemed a good social goal.

5.  Child Care Credit … to allow single mothers the ability to work … a worthy cause I am sure but one that does little to discourage out of wedlock children, single parent homes, latch-key children, the cycle of children who are brought up thinking this sort of life style is appropriate.

Some will think I am harsh by the entitlements that I point out. I am not trying to say that none of them are valid I am just arguing that there should be no sacred cows. No matter which section of the tax code you try to eliminate someone’s ox is being gored. It is time to start over with the clean slate.