IRS summons fishing expedition?

[Judge Roy Bean]

Odd situation, to say the least. A loan servicer is allegedly being summonsed by the IRS to supply copies of the original loan documents as well as evidence of assignment and recording of a taxpayer's mortgage. Problem is, borrower/taxpayer has very recently discovered the mortgage has never actually been recorded.

Will the IRS consider the mortgage deduction being taken by the borrower/taxpayer valid if it indeed hasn't been recorded?

[jkeeb]

I cannot see that as a problem. Are you sure your client is telling you all? The only reason I can see for the summons is for non filing or non payment issues. If I were examining someone regarding mortgage interest, I would only care to see evidence of payment (checks, 1098) and copy of the loan agreement.

[Famspear]

Don't always trust the Form 1098 reports!

A few months ago, I had a client who was examined by the IRS where the Revenue Agent wanted to see lots of documentation related to the client's home mortgage interest expense deduction (although the Agent did not specifically ask for evidence that the mortgage had been "recorded," which would not seem to be determinative as to whether the home mortgage interest expense deduction is allowable anyway). The deal was that the total deduction for the year in question was about $100,000. We had several Form 1098 reports for everything, but it turned out that two of the LENDERS had made errors: some of the interest amounts (a lot, actually) were not paid in connection with loans secured by the taxpayer's residence. The interest amounts should not have been reported on Form 1098 reports.

However, because I was able to show the Revenue Agent that those interest expense items were properly classified as investment interest expense AND because I was able to show the Revenue Agent that the taxpayer had tons of investment income to completely offset the reclassified investment interest expense, the IRS closed the examination with "no change." I suspect that the reason the IRS examined the home mortgage interest expense deduction was simply its large amount. Note: Back when I had prepared the Form 1040 return, there seemed to be no important reason for me to challenge the various Form 1098s, as the taxpayer had invested well over a million dollars in the home in question, and had borrowed lots of that money. However, lenders do sometimes make mistakes by mis-classifying investment interest expense as "home mortgage" interest, and I believe the fine print on Form 1098 does specifically warn taxpayers about penalties if a Form 1098 amount has been mis-classified. I learned my lesson about trusting Form 1098 reports.

Judge, it does seem odd that the IRS would issue a third party summons for the data in your case. Also, I'm not sure why the IRS cares whether the mortgage was recorded, unless they either don't understand the purpose of recordation, or they just want to "paper the file" a bit more. For purposes of section 163(h), there's no requirement that a secured debt be perfected by recordation, etc., in order for the interest expense to qualify as home mortgage interest, is there?

[Judge Roy Bean]

Not a client - an emailed question about a borrower going to court to challenge an IRS summons that was served on the servicer of the loan. Apparently it's a privacy driven issue. The borrower believes the summons is overbroad. I'll have to ask to get the actual case, but at first glance it seems the 1098 for that year would have been sufficient to make a deductibility determination.

And in reality, whether the loan was recorded affects only the lender/trustee's interest in the property. If the IRS considers the 1098 figure suspicious I can't see how the recordation has any relevance.

I'll respond and see if we can actually find the case.

[Judge Roy Bean]

As usual with some of the semi-cryptic questions I get from time to time, there is more to the story.

An Arizona couple filed four years of returns (03, 04, 05, 06) in mid August - I'm not going to ask why. Prior to that submission, they received a copy of a summons issued to their mortgage servicer which asks for:

The following information in your records regarding mortgage held by you on property owned by [ taxpayer names ] with addresses [ two adjoining addresses ]. Your account number is [ account ] but not limited to this account but all accounts for the owner identified above with SSN of [ SSAN's ].
(1) Original amount of obligation (mortgage)
(2) Balance due on obligation (mortgage)
(3) Kind of property involved
(4) Amount of each payment
(5) How account is secured
(6) Date and place instrument was recorded
(7) Mortgage application
(8) Last six payments: If done by check, need copy of it and if done electronic transfer I need the name of the financial institute [sic] account number, name stated on the account and copy of payment.

The couple has filed a petition to quash the summons which in part avers:

Based on the filing of Petitioner's tax returns, signed under penalty of perjury, for the periods in question, the information sought by Respondent is now within its possession, thus eliminating the need for enforcement of the Summons.

Respondent has made no determination that further examination of Petitioner's records are necessary, and/or has not notified Petitioner in writing to that effect.

Under United States v. Powell, 379 US 48, 57-58 (1964), the information sought by Respondent is already in its possession, and there has been no determination by Respondent that any further information is necessary, and Petitioner affirmatively contends that no further information should be required.

Enforcement of the Summons would amount to the use [of] legal process or procedure primarily to accomplish an ulterior purpose for which the process or procedure was not designed.

WHEREFORE, Petitioner requests relief as follows:

(a) For an order of the Court quashing the Summons; and
(b) For any further relief the court deems just and necessary.

Some items of note - number one, the servicer is notoriously opportunistic with more than thirty new civil cases (NOT foreclosures) filed against them every month. Apparently, they have not recorded the mortgage in question but have filed 1098s.

The couple strongly believes the figures the servicer will supply will be no better than the nonsense they have gotten from them in the past when discrepancies have come up and may conflict with what they submitted on the returns. (Note also that the list does not include the amount of interest paid.)

Although they don't say so, I think their biggest issue is or should be the mortgage application. Given the nature of some of the loans that have been generated over the last decade, I suspect the IRS agent will see inflated income numbers for the year the application was made, especially if this was one of the Alt-A no-doc loans. Having said that, I'd be willing to bet a decent bottle of Patron that the servicer will report that they can't find the application - what the IRS gets with a summons vs. what the borrowers have been told may be two different things.

It will be interesting to see where this goes. Frankly, I doubt the IRS will be able to ascertain the amount of interest paid with the information they get from this summons. Without the note to determine how payments are credited and a full payment history to detail it, they could come up with even more ridiculous numbers than the servicer has on more than one occasion.

Thoughts?

[jkeeb]

As an agent, if I were to be assigned a non-filer, and I had information regarding a mortgage, I would summons the mortgage information. Hopefully, I would be able to follow the process back to the originator and the self stated income as a start to sources of income. Any mortgage payments may lead to a checking account that I do not know about. Those summons will be forthcoming. Now that the taxpayer has filed returns, the situation may change. If the returns look halfway reasonable (given the apparent living conditions of the taxpayers) the agent may very well drop the case. Of course if the taxpayers are acting like there is something to hide, most agents would discuss with their manager first.