Tax Court in Brief | Howland v. Commissioner | Mortgage Interest Deduction in Foreclosure Sale and Accuracy Penalty | law of the free man

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Tax litigation: The week of June 13, 2022 to June 17, 2022

  • Phillips v. Comm’r, TC Memo. 2022-58 | June 13, 2022 | Lauber, J. | Dekt. No. 18553-21L
  • Chavis v. Comm’r, 158 TC No. 8 | June 15, 2022 | Lauber, J. | Dekt. No. 11835-20L
  • Hatfield vs. Comm’r, Memo TC. 2022-59 | June 13, 2022 | Lauber, J. | Dekt. Nos. 7327-20, 1500-21
  • Romana v. Commissioner, TC Summary Notice 2022-9 | June 16, 2022 | Carluzzo, J.| Dekt. No. 1156-21S
  • Kellet c. Comm’r, TC Memorandum 2022-62 | June 14, 2022 | Greaves, J. | Dekt. No. 21518-18
  • Walker vs. Commissioner, Memo TC. 2022-63 | June 15, 2022 |Néga, J.| Dekt. No. 16958-18L

Howland v. Commissioner, TC Memo. 2022-60 | June 13, 2022 | Weiler, J. | Dekt. No. 17526-19


Summary: In 2007, Ronald Howland, Jr. and Marliee Howland (together, Howland) entered into a credit agreement with a bank, consisting of a promissory note and mortgage secured by their principal residence, in respect of a line of credit of up to 390 $000 (credit agreement). This credit agreement was secondary to a first mortgage held by another lender. Under the terms of the credit agreement, Howland’s payments were applied first to interest and then to principal. Howland breached the credit agreement and the bank filed a foreclosure suit. At the time, Howland owed $377,060 in principal on the credit agreement, plus accrued interest, fees and other charges. In the foreclosure action, the bank sought compensation for the full amount owed, including the right to seize Howland’s residence. In 2016, a foreclosure sale of the Howland home was ordered and the home was sold to the buying bank for $321,000. At the time of the foreclosure sale, the sum of accrued interest on the credit agreement was $100,607. Also in 2016, a second foreclosure complaint regarding the Howland residence was filed by the first mortgage holder. This lender claimed a balance owing in principal, interest, late fees, attorney’s fees and other authorized expenses of $247,046. On December 30, 2016, the foreclosure buyer bank sold the residence for $594,000. No Internal Revenue Service (IRS) Form 1098, Mortgage Interest Statement, was issued to Howland for the 2016 tax year for the mortgage interest in question. Howland timely filed a joint 2016 Form 1040, claiming a mortgage interest deduction of $103,498 on Schedule A. On October 1, 2018, the IRS sent the petitioners a 566-S letter and Form Auto-generated 14809, Interest you paid, requesting an explanation of mortgage interest deduction claimed. In response, Howland provided documents to the IRS. The Revenue Officer (RA) reviewed the 2016 Form 1040 and completed the “Substantial Understatement of Penalties Introduction Sheet” (Penalty Introduction Sheet). On May 9, 2019, the IRS sent Howland IRS Letters 692–M and 937(SC), including Form 4549, Income Tax Examination Changes, and Form 886–A, Explanation of Items, and the immediate supervisor of RA approved the penalty sheet. that same day.

Key issues:

  • Based on a set of stipulated facts, the issues to be determined are (1) whether Howland is entitled to a mortgage interest deduction of $103,498 claimed on Schedule A, Itemized Deductions, of their Form 1040, Statement of personal income tax in the United States, for the 2016 tax year and (2) whether Howland is subject to the accuracy penalty under section 6662(a).

Main holdings:

  • While the credit agreement provided that repayments on the note were to be applied first to interest and then to principal, Howland did not present sufficient evidence to show that the amount paid by the acquiring bank under the foreclosure sale was applied by the lending bank first to interest (and not principal) owed by Howland under the credit agreement. The filing said nothing about how the acquiring bank used the funds received and whether Howland owed any remaining principal balance. Thus, the deduction of interest was not allowed.
  • Howland has made a reasonable and good faith attempt to comply with tax requirements in circumstances involving a complex matter. The court found that Howland should not be assessed an accuracy penalty under section 6662(a).

Main points of law:

  • Burden of proof. Generally, IRS determinations are presumed to be correct and the taxpayer bears the burden of proving them wrong. Rule 142(a); Welch versus Helvering, 290 U.S. 111, 115 (1933). The burden of proof may shift to the IRS if the taxpayer establishes that it has complied with the requirements of section 7491(a) to substantiate the items, maintain the required records, and fully cooperate with the taxpayer’s reasonable requests. ‘IRS.
  • Interest deduction. Generally, a taxpayer can claim a deduction for “all interest paid or accrued during the tax year on debt”. CR § 163(a). Mortgage interest on debt secured by a mortgage on a taxpayer’s residence may be deductible as qualified residence interest (QRI). IRC § 163(h)(2)(D), (h)(3). Interest is only deductible when paid or accrued during the tax year. See IRC § 163(a). A cash-basis taxpayer can deduct interest only when paid, either in cash or its equivalent (including the transfer of title to the lender in payment). Helvering versus Price309 US 409 (1940); Hilsheimer v. Commissioner, Memo TC. 1976-284, 35 TCM (CCH) 1275.
  • Amount of interest paid. Interest is defined as “compensation for the use or withholding of money”. MP c. of the bridge, 308 U.S. 488, 498 (1940). The general rule in this matter is that voluntary partial payments made by a debtor to a creditor are, in the absence of agreement between the parties, charged first to interest and then to principal. See Lackey v. Commissioner, Memo TC. 1977-213, 36 TCM (CCH) 890. However, an exception to this general “interests first” rule exists in the case of an involuntary foreclosure of mortgaged property where the evidence “strongly indicates” that the mortgagor is insolvent at the time of foreclosure. See Newhouse v. Commissioner59TC 783, 789 (1973).
  • Section 6662(a) Accuracy Penalty. The accuracy penalty does not apply to any part of an underpayment if it is shown that there was reasonable cause for the taxpayer’s position and the taxpayer acted in good faith at the regard to this part. RC § 6664(c)(1); Treasures. Reg. § 1.6664-4(a). The determination of whether a taxpayer acted with reasonable cause and in good faith is made on a case-by-case basis, taking into account all relevant facts and circumstances, the most important of which is the extent of the efforts made by the taxpayer to assess his or her tax payable for the year. Treasures. Reg. § 1.6664-4(b)(1). The taxpayer bears the burden of proof as to reasonable cause. Higbee v. Commissioner116 TC 438, 446 (2001).

Knowledge: In the context of the application of mortgage interest tax deduction rules to amounts paid by a purchasing entity in connection with a foreclosure sale that extinguishes an underlying debt, the “interest first » against the involuntary payment of interest is determined by the valuation of the underlying loan, mortgage, or credit agreements as well as the manner in which the purchase price is applied by the beneficiary creditor in the event of foreclosure. A taxpayer must present sufficient evidence for the IRS and ultimately the Tax Court to conclude that a portion of the foreclosure sale proceeds was in fact applied to interest owed by the taxpayer. And, the taxpayer must not be insolvent at the time; otherwise, the interest payment may be considered “involuntary” and therefore a deduction not available under the “interest first” rule.

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