I am in dispute with the IRS over my 2007 tax returns. I had claimed over $56,000 deduction for mortgage interest paid to a UK bank for a UK property. IRS queried it because they had not received a form from a bank confirming the amount of mortgage interest I had paid.

I explained to them that the mortgage had been taken out with a foreign (i.e. UK) bank that had no obligation to report interest paid to the IRS and sent them (again!) the mortgage interest paid statement from the UK bank.

However, they are now disallowing my claim for home mortgage interest paid because they say that foreign interest is not deductible on Schedule A.

The threads I have read suggest that foreign interest is in fact deductible on Schedule A.

And what is this about withholding 30% of my interest payments to a foreign bank? What business is it of the IRS what a foreign bank does with money I am spending in a foreign country?

The reason the IRS views this interest as NOT deductible is very simple: they cannot tax the interest at the source (the bank).

Home mortgage interest paid to a U.S. bank is taxed by the IRS as bank income. As you noted, the IRS cannot tax that interest, which is probably why they disallowed your interest deduction. It is easier than requiring you to 30% of the interest payments to the bank, something they CAN and HAVE done in the past.

I agree with your assessment that interest paid on a foreign property is deductible; ask the IRS to cite the IRC that states such interest is NOT deductible, and pass it along to the rest of us when and if you get it.

Many thanks. I spoke with the IRS twice today.

In the first instance, they referred me to Publication 936, which I have now read twice. Nowhere does it state that mortgage interest paid on a foreign property is NOT deductible.

I reported this back to another agent who consulted with someone higher up. She advised me to write to the Tax Examiner explaining this. The Tax Examiner would then ‘research the law’ and make a decision. I stressed that the ‘law’ ought to be spelled out clearly in the publication that guides tax payers.

I am NOT surprised by the answer, because, having read IRS Pub 936, I too could NOT find any citation that interest paid on a foreign property was not deductible.

Let us know what the Tax Examiner has to say.

I spoke to another IRS Agent on 24 July who confirmed that he could not find anything in either IRS Publication 936, Form 1116 or the Schedule A Instructions that said foreign interest paid was not deductible, so he has written an Action Note to the Tax Examiner on the case and asked them to call me. As of today 29 July they have not called me back.

Such procedures routinely take 15 days to complete.

I am wondering if perhaps the IRS is focusing on a technicality. The examiner has said that Foreign Interest is not deductible on Schedule A. Perhaps I should have claimed the interest deduction on Form 116 instead. If I had done this, would it have made any difference in the overall tax due?

Form 1116 is used to claim a Foreign Tax Credit for taxes paid on interest INCOME, not mortgage interest paid.

Home mortgage interest is deductible. You are paying the IRS, so you live here, not in the UK house which is an investment property, not your residence.

I have just heard back from the IRS who have reversed their position and now say that foreign mortgage interest IS deductible but are continuing to disallow my claim, as I have not provided enough other documentation. I have sent off the documents asked for and hopefully will have a favourable judgment.

For the record, I am a US citizen, but a UK resident. The mortgage interest in question is for our second UK home.

I am still perplexed by their mistake in tax law. These examiners are professionals who specialise in a particular area. (e.g. my tax examiner was from the Excess Mortgage Interest section) So they should know their subject backwards and forwards. Perhaps they were just ‘trying it on?’

The IRS is not some omnipotent god who is infallible. It is in fact a bureaucracy manned by human beings who sometimes make mistakes, and not every IRS employee who answers the phone is a highly-paid IRS agent.

Given the complexity of U.S. tax law, I am surprised that mistakes of this nature are not more common.

This looks like it's been resolved but I owned property in Canada (I'm in the US) and IRS took the position that mortgage interest IS deductible, no matter where it is paid.

Just sayin'.