October 31st, 2009 
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The Internal Revenue Service has delivered a valuable gift to those with $1 million-plus mortgages on their mansions. (ABC News Photo Illustration)
The Internal Revenue Service has delivered a valuable gift to those with $1 million-plus mortgages on their mansions. In an internal legal memo released publicly last month, the IRS concluded that a taxpayer can deduct interest on the first $1.1 million of a home mortgage–$100,000 more than earlier legal findings allowed.
The ruling is a boon to the 137,670 taxpayers who, according to First American CoreLogic, a mortgage data firm, have mortgage balances above $1 million.
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Depending on their tax bracket and the interest rate on their jumbo mortgages, the affected homeowners could save $3,000 a year or more, figures Kaye Thomas, a tax lawyer who publishes a tax guide at www.fairmark.com. Moreover, taxpayers can file amended returns for the past three years and claim thousands in refunds. “Most people would think that’s worthwhile,” Thomas says. (For more on time limits for filing an amended return and claiming a refund, click here.)
Here’s the background. The law allows homeowners to deduct interest on two types of home debt–purchase (or acquisition) indebtedness up to $1 million and home equity indebtedness up to $100,000. Previously, two U.S. Tax Court memorandum decisions held that for a purchase of a home with a mortgage of $1.1 million, you could deduct interest on only $1 million. The reasoning: The extra $100,000 didn’t count as home equity debt, but as purchase indebtedness subject to the $1 million cap. Some taxpayers have structured their affairs to claim the full $1.1 million, but others have settled for $1 million.
The IRS memo–which was sent by the IRS Office of Chief Counsel to lawyers within the IRS–states that a taxpayer who buys a $1.5 million home, borrowing $1.3 million, can deduct interest on $1.1 million. The memo recognizes that this interpretation is different than the old tax court decisions, and states: “We believe that the position in this memorandum is the better interpretation.” The reasoning: The amount of a residential mortgage above $1 million can be treated as home equity debt. The first $1 million counts as purchase indebtedness, and $100,000 of the excess over $1 million counts as home-equity indebtedness.
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