With tax season upon us, a recent IRS ruling has important impact on a subject that will be of interest to many taxpayers who co-own property with a person who is not their spouse.

First, let’s review the basic rules on home mortgage interest deduction. Taxpayers who itemize deductions on Schedule A can include interest paid on mortgages with certain limits. Only interest paid on a loan secured by a principal residence, and a second home, is deductible. Additionally, taxpayers can only deduct interest on loans for which they are legally liable. So contributing to the payments on a loan for someone else will not qualify.

Assuming these criteria are met, the amount of interest a taxpayer can claim is limited. Taxpayers cannot deduct the interest on more than $1,000,000 of debt for their first and second residence together. Married couples filing jointly are limited to $1,000,000 for the couple, and if they file separately the limit is reduced to $500,000 each. In addition, a taxpayer can also deduct the interest on the first $100,000 of home equity loan debt. So an unmarried taxpayer with a mortgage and home equity line of credit could deduct the interest on $1,100,000 in total.

But what if an unmarried couple jointly owns a home together that has more than $1.1 million of qualifying mortgage debt? Can each taxpayer deduct the full extent of their individual limit? Prior consensus had always been yes. But recently, the IRS ruled that the limit should be applied applied by residence, not by taxpayer. Thus, one or two homes which are the principal and second homes cannot provide more than a total of $1.1 million interest credit no matter how many taxpayers own the homes. Once the $1.1 million of interest deduction is used from the first and second home, no further interest deduction can be claimed.

An example will help. Suppose Bob and Sue own two homes jointly and are not married. The principal residence has a first mortgage debt of $1,500,000, and the second home has a first mortgage debt of $1,000,000. There is no home equity loan in place on either. According to this ruling, Bob and Sue cannot together claim interest on more than $1,000,000 of total mortgage debt, despite the fact that they file separately and are not married, because the mortgage debt is related to the same first and second homes. If instead, Bob owned property one with debt of $1,500,000, and Sue owned property two with debit of $1,000,000, then each taxpayer could claim the full $1,000,000 limit providing they were otherwise eligible.

Tax planning can help in this situation. Non-married couples who own a first and second home should consider structuring transactions to have one home owned entirely by the first taxpayer and a second home owned entirely by the second if this is possible. Under that scenario each taxpayer should be able to deduct the full extent of the interest on $1,000,000, rather than splitting it as they would when owning both homes jointly. Non-married co-ownership is common in our market and likely on the increase, so be careful to consult tax advisers before purchasing to ensure that the structure permits maximum deduction.