T.C. Summ ary Opi ni on 20 14 -4

UNITED STAT ES TAX COURT

YONG J. DONG A

ND LIJUN W ENG, Peti ti on ers v. COMM ISSI ONER OF INTERNAL REVENUE, Resp on de nt

Doc ke t No . 23 20 4- 12 S. File d J an ua ry 9, 2 01 4.

Fran k Ag os ti no , forpe ti ti on ers . Peg gy J. Garte nb au m

an d M ic ha el Sih ks ne l, fo r res po nd en t.

SUMM ARY OPINION ARMEN, Sp eci al Trial Ju dg e: Thi s ca se was h eardpu rs ua ntto th e pr ov is io ns of s ect io n 7 46 3 o f th e In te rn al Rev en ue Co de in effe ctwhen th e- 2 -

pe ti ti on was fi le d. Pur su an t t o s ect io n 7 46 3( b) , th e d eci si onto be en te redis no t 1
rev ie wab le by any

ot he r co urt, an d thi s o pi ni on sh al l n otbe tre at edas p rece de nt fo r an y ot he r cas e. Res po nd en t d et erm in edde fic ie nc ie s i n p et it io ne rs ’ Fed eral in co m e ta x fo r 20 07 an d 2 00 8 o f $1 5,8 02 an d $ 14 ,93 2, re sp ect iv el y . Afte r co nc es si on s b y

th e p art ie s, th e so le is su e rem ai ni ng forde ci si on is

2 whe th er p et it io ne rs are en ti tl edto ho m e m ortg ag e in te res t d educ ti on s fo r 20 07 an d 20 08 in ex ces s o f th e am ou nt s re sp on de ntall owe d. We ho ldth atth ey are n ot . Bac kg ro un d Thi s ca se was s ub m it te d fu ll y st ip ul at edun de r Ru le 12 2. We in co rp or at e b y refe ren ce the pa rti es ’ st ip ul at io n o f fac ts , sec on d s ti pu la ti on of f act s, s ti pu la ti on of
se tt le d i ss ue s, an d a cco m pa nyin g e xh ib it s.

Unl es s o th erwi se in di cat ed , all subs eque ntsec ti on refe ren ces are t o t he 1 In te rn al Rev enue Co de in effe ctforth e y ears in is su e. All Ru le refe ren ces are t o th e Tax Co urt Ru le s o f Prac ti ce an d P ro cedur e. Fo r 20 07 an d 2 00 8 p et it io ne rs co nc ed e th atth ey are en ti tl edon ly to t he 2 de du ct io ns on th ei r Sch edul es E, Sup pl em en ta l In co m e an d Lo ss , as d et erm in edin res po nd en t’s n ot ic e o f de fic ie nc y . Res po nd en t co nc ed es all of t he ad jus tm en ts on Sch edul es A, Item iz edDedu ct io ns , ot he r th anth e h om e m ortg ag e in te res t de du ct io n. Th e p art ie s ag ree t ha t t he co m pu ta ti on al ad

jus tm en ts to pe ti ti on ers ’ it em iz edde du ct io ns wil l b e m ad e o n t he ba si s o f th e o ut co m e o f th e is su e reg ard in g t he ho m e m ortg ag e in te res t d educ ti on .- 3 -

Pet it io ne rs res id edin th e St at e o f New York a t t he ti m e th atth e p et it io n was fil ed
. At al l re le va ntti m es pe ti ti on ers ha ve own edth e p ro pe rty at 5 0t h Av en ue , Oak landGard en s, New Yo rk(Oak la ndGard en s p ro pe rty), andha ve us editas th ei r pr im ary res id en ce. InJu ne 20 05 , aro un d t he ti m e p et it io ne rs acqui redth e Oak la ndGard en s pr op erty , th ey

en te redin to a lo anag reem en t wi th pe ti ti on er Yo ng J. Do ng ’s pa ren ts , Xin g M in g Do ng an d Han g Li anYang , in res pe ctof t he Oakl an d Gar de ns pr op erty . This was c omm em or at edin th e “ Hom e Equ tt y [si c] LoanAgre em en t” (lo anag reem en t) a nd“ Hom e Equ ii ty [sic ] Deedof Tru st ” (d eedof tru st ). The l oa n ag reem en t al lo ws fo r a l oa n a m ou ntup to $1 30 ,00 0 wi th anin te res t ra te of 3 .5% pl us a pr im e rat e n otto ex ceeda 12 % an nu al rat e. Thi s was no t a p ur ch as e m on ey
m ortg ag e; rathe r, itap pe ars to ha ve be ena cred itli ne m ortg ag e. The lo anag reem en t p ro vi de s t ha t p et it io ne rs ’ in te res t i n t he Oakl an d Gard en s p ro pe rty is s pe ci fic sec ur it y forth e p aym en t o f th e d eb t. The lo anag reem en t an d t he de edof tru stwere n ev er re co rd edin an y juri sd ic ti on . The p art ie s ag ree t ha t New Yo rkSta te law g ov ern s t he lo an ag reem en t an d t he de edof t ru st .- 4 -

In20 07 pe ti ti on ers m ad e p aym en ts pu rs ua ntto th e lo anag reem en t t ot al in g $2 6,4 42 . In 2 00 8 p et it io ne rs m ad e p aym en ts pu rs ua ntto th e lo anag reem en t to ta li ng $2 6,1 62
. Pet it io ne rs ti m el y

fil edth ei r 20 07 an d 2 00 8 F ed eral in co m e ta x re tu rn s. On th ei r 20 07 tax return p et it io ne rs cla im eda ho m e m ortg ag e in te res t d educ ti on to ta li ng $7 0,7 84 . On th ei r 20 08 tax return p et it io ne rs cla im eda ho m e m ortg ag e in te res t d educ ti on to ta li ng $7 1,4 31
. InJu ly 201 2 re sp on de ntis su edpe ti ti on ers a ti m el y no ti ce o f de fic ie nc y , de te rm in in g d efi ci en ci es of $ 15 ,80 2 fo r 20 07 an d $ 14 ,93 2 fo r 20 08 . The n ot ic e o f de fic ie nc y

di sa ll owe d, i nt er al ia , $2 6,4 42 of t he $7 0,7 84 pe ti ti on ers cla im edon th ei r 20 07 tax return a nd$2 6,1 62 of t he $7 1,4 31 pe ti ti on ers cla im edonth ei r 20 08 ta x re tu rnwit h re sp ectto th ei r ho m e m ortg ag e in te res t d educ ti on s. Th e p orti on s di sa ll owe d wer e at tri bu tabl e to pa ym en ts pe ti ti on ers m ad e to Xin g M in g Do ng an d Han g Li anYang in co nn ect io n wi th th e lo anag reem en t i n re sp ectof t he Oakl an d Gard en s p ro pe rty. Pet it io ne rs fil eda ti m el y

pe ti ti on forred et erm in at io n wi thth e Co urt fo r 20 07 an d 2 00 8.- 5 - Dis cu ss io n 3 Deduc ti on s ar e al lo wedso le ly as a m at te r of leg is la ti ve gra ce. Dep ut y v. du Po nt , 30 8 U.S. 4 88 , 49 3 (1 94 0) ; New Co lo ni al Ice Co . v. Hel ve rin g, 2 92 U.S. 43 5, 44 0 (1 93 4)
. As a g en eral rul e, a ta xp ay er m ay cla im a de du ct io n fo r “ al l i nt eres t p ai d o r
accrue d wi th inth e ta xabl e y ear o n i nd eb te dn es s.” Se c. 16 3( a). In de bt edne ss
m ean s an un co nd it io na l an d l eg al ly enfo rceabl e o bl ig at io n fo r th e p aym en t o f
m on ey . Aut en rei thv. Co m m is si on er, 1 15 F.2d85 6, 8 58 (3dCir . 19 40 ), aff’g 4 1 B.T.A. 31 9 (1 94 0) ; Li nd er v . Comm is si on er, 6 8 T.C. 7 92 , 79 6 (1 97 7)
. 4 Sect io n 1 63 (h ) pr oh ib it s an in di vi du al tax pay er fro m cla im in g ade du ct io n fo r pe rs on al in te res t p ai d o r acc ru eddu rin g t he tax ab le y ear. On e o f th e li m it ed
ex cep ti on s t o t hi s g en eral rul e p erm it s i nd iv idua ls to de du ctqu al ifi edres id en ce in te res t. Sec . 16 3( h) (2 )(D). Qua li fie d re si de nc e in te res t i s i nt eres t p ai d o r acc ru ed

The i ss ue forde ci si on in th is cas e is leg al an d n otfactua l i n n atur e. 3 Acco rd in gl y , th e b ur de n o f pr oo f do es no t i nf orm th e d eci si on al pro ces s. Whe re the tra ns act io n g iv in g ri se to th e cl ai m edin de bt edne ss is be twee n 4 fam il y m em be rs , th e ev id en ce p res en te d t o e st ab li sh su ch a de btm us t b e cl os el y sc ru ti ni zedforeco no m ic subs ta nc e. See Woo dwa rdv. Un it edSta te s, 2 08 F.2d 89 3 (8 thCir . 19 53 ); Wale s v . Comm is si on er, T.C. Mem o. 1 97 8- 12 5, af f’d wit ho ut publ is he d o pi ni on , 62 4 F .2d19 5 (9 th Cir . 19 80 ). Res po nd en t d oe s n otdi sp ut e th e bo nafid e n atur e o f th e in de bt edne ss , bu t d is pu te s o nl y pe ti ti on ers ’ co m

pl ia nc e wit h s ec. 1 63 (h )(3 ) reg ard in g t he sec ur edna tu re o f th e in de bt edne ss .- 6 -

du rin g t he tax ab le y ear o n a cqui si ti onin de bt edne ss or h om e equi ty ind eb te dn es s wit h re sp ectto an y

qu al ifi edres id en ce o f th e ta xp ay er. See sec . 16 3( h) (3 )(A). A qu al ifi edres id en ce i nc lu de s a t ax pay er’s p rin ci pa l re si de nc e. Sec. 16 3( h) (4 )(A)(i )(I). The pa rti es do no t d is pu te th atth e Oak la ndGard en s p ro pe rty was pe ti ti on ers ’ pr in ci pa l re si de nc e. The d is pu te is whethe r pe ti ti on ers ’ pa y m en ts to Xin g M in g Do ng an d Han g Li anYang co ns ti tu te d qua li fie d re si de nc e in te res t. Pet it io ne rs co nt en d t ha t t he am ou nt s p ai d t o Xi ng Mi ng Don g a ndHang Lian Yan g i n 2 00 7 a nd20 08 were “ qu al ifi edres id en ce i nt eres t” un de r se ct io n 16 3( h) (3 ). Becaus e n ei th er the lo anag reem en t n orth e d eedof t ru stwas re co rd ed , res po nd en t co nt en ds to th e co nt rary. Qua li fie d re si de nc e in te res t i s an y in te res t p ai d o r acc ru eddu rin g the ta xabl e y ear o n a cqui si ti on in de bt edne ss or h om e equi ty ind eb te dn es s tha t i s
se cu redby the qu al ifi edres id en ce o f th e ta xp ay er. Sec ti on 16 3( h) (3 ) pr ov id es in pa rt: (B) Acq ui si ti on in de bt edne ss .--

(i) In g en eral .--Th e te rm

“ acqui si ti on in de bt edne ss ” m ean s an y in de bt edne ss whi ch
--- 7 - (I) i s i nc urredin acqui rin g, co ns tru ct in g, o r subs ta nt ia ll y

im pr ov in g a ny qu al ifi edres id en ce o f th e ta xp ay er, an d (II) i s s ecu redby suc h re si de nc e. * * * * * * * (C) Ho m e equi ty ind eb te dn es s.-- (i) In g en eral .--Th e te rm

“ ho m e equi ty ind eb te dn es s” m ean s an y in de bt edne ss (ot he r th anacqui si ti on in de bt edne ss ) se cu redby a qu al ifi edres id en ce t o t he ex te ntth e ag gr eg at e am ou ntof s uc h in de bt edne ss do es no t ex ceed
--

(I) t he fai r m ark etva lu e o f su chqu al ifi edres id en ce, reduc edby (II) t he am ou ntof a cqui si ti on in de bt edne ss wit h re sp ect to su ch res id en ce. Bec au se bo th acqui si ti on in de bt edne ss an d h om e equi ty ind eb te dn es s requi re the in de bt edne ss to be sec ur edby the pro pe rty, we loo k t o t he sec ur it y of th e lo anbe twee n p et it io ne rs an d Xi ng Mi ng Don g a ndHang LianYang to de te rm in e whe th er p aym en ts onitare qua li fie d re si de nc e in te res t. Purs ua ntto sec . 1.1 63 -1 0T(o )(1 ), Tem

po rary Inco m e Tax Reg s., 5 2 F ed . Reg . 48 41 7 (De c. 22 , 19 87 ), se cu redde btm ean s: a d eb t t ha t i s o n t he sec ur it y of any ins tru m en t (s uc h a s a m ortg ag e, de edof t ru st , or l an d c on tra ct )--- 8 - (i) Thatm ak es th e in te res t o f th e d eb to r in th e qua li fie d res id en ce s pe ci fic sec ur it y forth e p aym en t o f th e d eb t, (ii ) Und er wh ic h, i n t he ev en t o f de fau lt , th e res id en ce co ul d b e subjec te d t o t he sat is fact io n o f th e d eb t wi th th e sa m e p rio rit y as a m ortg ag e o r de edof t ru stin th e juri sd ic ti onin whi ch th e p ro pe rty is si tu at ed , and (ii i) Th atis reco rd ed , wher e p erm it te d, o r is othe rwis e pe rfec te d i n a cco rd an ce wi th ap pl ic ab le Sta te law. The parti es ag ree t ha t t he lo anag reem en t p ro vi de s t ha t p et it io ne rs ’ in te res t i n t he Oak landGard en s p ro pe rty is s pe ci fic sec ur it y forth e p aym en t o f th e d eb t. See
se c. 1.1 63 -1 0T(o )(1 )(i ), Tem po rary Inco m e Tax Reg s., s up ra. The refo re, pe ti ti on ers ha ve sat is fie d t he fir stele m en t o f a s ecu redde btun de r th e reg ul at io ns . See i d. Howev er, n ei th er the lo anag reem en t n orth e d eedof t ru stwas re co rd edin
an y juri sd ic ti on . Fail ur e to reco rdth e d eedof t ru stm ay serve to subo rd in at e itto th e in te res ts of t hi rdpa rti es wit ho utactua l n ot ic e o f it , who are p ro te ct edby the New Yorkreco rd in g s ta tu te . See N.Y. Real Pro p. Law s ecs . 28 1, 2 91 (McKi nn ey 20 06 & Supp . 20 13 ); s ee al so Tran sl an d As se ts , Inc . v. Dav is , 81 3 N.Y.S.2 d 6 75 (Ap p. Di v. 2 00 6) . N.Y. Real Pro p. Law s ec. 2 81 pro vi de s:

(1 ). (a) Fo r th e p ur

po se s o f th is sec ti on , a “ cred itli ne m ortg ag e” s ha ll m ean an y m ortg ag e o r de edof t ru st* * * wh ic h st at es th atitsec ur es in de bt edne ss un de r a n ot e, cred itag reem en t o r ot he r fi na nc in g a gr eem en t t ha t re fle ct s t he factth atth e p art ie s- 9 -

reas on ab ly con te m

pl at e en te rin g i nt o aser ie s o f adva nc es , paym en ts an d re ad va nc es , andth atli m it s t he ag gr eg at e am ou ntat a ny tim e ou ts ta nd in g t o am ax im

um am ou ntsp eci fie d i n s uc h m ortg ag e o r de edof t ru st . * * *

* * * * * * * (2 ). Any cred itli ne m ortg ag e m ay , andwhenso ex pr es se d th erei n, s ha ll sec ur e n oton ly the ori gi na l i nd eb te dn es s b utals o t he in de bt edne ss crea te d b y

futur e ad va nc es th ereu nd er m ad e wit hi n twen ty five y ears fro m

th e d at e o f th e rec or di ng of s uc h c red itli ne m ortg ag e, whe th er s uc h a dv an ces are o bl ig at ory or a re t o b e m ad e at th e o pt io n o f th e le nd er o r ot he rwis e, to th e sa m e ex te ntan d wi thth e sa m e p rio rity

of l ie n a s i f su ch futur e ad va nc es ha d b een m ad e atth e ti m e su ch cred itli ne m ortg ag e was reco rd edpu rs ua ntto sec ti on two hu nd redni ne ty-on e o f th is ch ap te r, al th ou gh th ere m ay ha ve be enno ad va nc es m ad e atth e ti m e o f th e ex ecu ti onan d a ckno wled ge m en t o f su ch cred itli ne m ortg ag e, an d a lt ho ug h t he re m ay be no in de bt edne ss ou ts ta nd in g a t t he ti m e an y adva nc e is m ad e. * * * [Em ph as is ad de d.] N.Y. Real Pro p. Law s ec. 2 90 (3 ) de fin es a co nv ey an ce t o i nc lu de “ ev ery writ te n i ns tru m en t, b y

whi ch an y

est at e o r in te res t i n re al pro pe rty is * * *
m ortg ag ed* * *”
. N.Y. Real Pro p. Law s ec. 2 91 pro vi de s:

A con ve y an ce o f rea l p ro pe rty, with in th e st at e, on be in g dul y ackno wled ge d b y

th e p ers on ex ecu ti ng th e sa m e, orpro ve d a s requi redby th is ch ap te r, * * * m ay be reco rd edin th e o ffi ce o f th e cl erkof t he co un ty whe re s uc h re al pro pe rty is s itua te d, an d s uc h co un ty clerksh al l, upo n th e reque stof any part y , on ten de r of th e la wfu l fe es th eref

or , reco rdth e sa m e inhi s s ai d o ffi ce. Eve ry su ch co nv ey an ce n otso reco rd edis vo idas a ga in stan y pe rs onwho subs eque nt ly pur ch as es or a cqui res by exch an ge or c on tra ct s t o- 10 -

pu rch as e o r acqui re b y

ex ch an ge , th e sa m e rea l p ro pe rty or an y po rti on th ereo f, * * * i n g oo d fa ith a ndfora va lu ab le co ns id erat io n, fro m th e sa m e v en do r orass ig no r, hi s d is tri bu te es or d ev is ees , and who se co nv ey an ce, co ntractor a ss ig nm en t i s fi rs t dul y reco rd ed , and is vo idas a ga in stth e li enup on th e sa m e rea l p ro pe rty or an y po rti on th ereo f ari si ng fro m

pa ym en ts m ad e upo n t he ex ecu ti on of o r pu rs uantto th e te rm s o f a co nt ractwith t he same ven do r, hi s di st rib ut ees or d ev is ees , if s uc h c on tra ctis m ad e in go odfai th an d i s fir stdu ly recor de d. * * * [Em ph as is ad de d.] The refo re, und er New Yo rkSta te law, an un reco rd edm ortg ag e is in va li d ag ai ns t t hi rdpa rti es who do no t h av e actua l n ot ic e o f it . See i d. s ecs . 28 1, 2 91 ; W as hi ng to n M ut . Ban k, FA v . PeakHeal th Club, In c., 85 3 N.Y.S.2 d 1 12 (App
. Div . 20 08 ); s ee al so T & V Con st r., Inc . v. Cal ap ai , 93 5 N.Y.S.2 d 6 8 (Ap p. Di v. 20 11 ). In t he ev en t o f a d efau ltth e u nr eco rd edm ortg ag e wou ldno t b e su ffi ci en t to subjec t t he res id en ce t o t he sat is fact io n o f th e d eb t wi th th e sa m e p rio rit y as a
reco rd edm ortg ag e b ecau se th e u nr eco rd edm ortg ag e is va li d o nl y ag ai ns t a t hi rd pe rs on ha vi ng actua l n ot ic e o f it . See Wash in gt on Mu t. Ba nk , 85 3 N.Y.S.2 d 1 12 ;
se e al so Tran sl an d As se ts , Inc ., 81 3 N.Y.S.2 d 6 75 . There fo re, p et it io ne rs ha ve no t
sa ti sf ie d t he sec on d e le m en t o f a s ecu redde btun de r th e reg ul at io ns . See s ec. 1.1 63 -1 0T(o )(1 )(i i), Tem po rary Inco m e Tax Reg s., s up ra. Fi na ll y , bec au se th e d eedof t ru stan d t he lo anag reem en t wer e n otreco rd ed , we co ns id er wh ethe r th e d eedof t ru stor t he lo anag reem en t was ot he rwis e pe rfec te d u nd er New Yo rkSta te law. See sec . 1.1 63 -1 0T(o )(1 )(i ii ), Tem po rary- 11 -

In co m e Tax Reg s., s up ra. Pet it io ne rs ha ve no t, h owe ve r, al le ge d o r sh own th at th ey pe rfec te d the de edof t ru stor t he lo anag reem en t i n a ny oth er way. Neit he r ha ve th ey est ab li sh edth atth ere i s an ot he r way to pe rfec t the de edof t ru stor t he lo anag reem en t u nd er New Yo rkSta te law, n orare we awa re o f an y su ch way . Thu s, p et it io ne rs ha ve no t s at is fie d t he th irdele m en t o f a s ecu redde btun de r th e reg ul at io ns requi rin g t ha t a m ortg ag e o r de edof t ru stbe reco rd edor o th erwi se pe rfec te d u nd er ap pl ic ab le Sta te law. See id
. Bec au se pe ti ti on ers ’ in de bt edne ss to Xin g M in g Do ng an d Han g Li anYang
was no t a s ecu redde btor o th erwi se pe rfec te d p ur su an t t o S ta te law as de fin ed
un de r th e reg ul at io ns , m on ey s p ai d t o Xi ng Mi ng Don g a ndHang Lian Yang di d
no t co ns ti tu te qu al ifi edres id en ce i nt eres t. Acco rd in gl y , we su st ai n re sp on de nt ’s de te rm in at io n o n t hi s i ss ue . Co nc lu si on Inho ld in g fo r res po nd en t o n t he di sp ut edis su e, we ha ve co ns id eredall of th e arg um en ts adva nc edby pet it io ne rs , and , to th e ex te ntno t ex pr es sl y ad dr es se d,
we co nc lu de th atth os e arg um en ts do no t s up po rt ares ul t co nt rary to t ha t re ach ed he rei n.- 12 -

Inord er t o g iv e eff

ectto th e fo reg oi ng , Deci si on wil l b e en te redun de r

Ru le 15 5.