A recent Tax Court decision (Hargreaves) states the obvious, but is a good reminder for all.
The Court ruled that a married couple could not deduct mortgage interest that was added to the principal of their negative amortization loan, because they were cash basis taxpayers and, quite obviously, didn’t actually “pay” the amount in question.
Under the cash receipts and disbursements method of accounting, amounts representing allowable deductions generally must be taken into account for the tax year in which paid.
The delivery of a promissory note to satisfy an interest obligation, without an accompanying discharge of the note, is a mere promise to pay and not actually a payment in cash or its equivalent.
The good news in this case is that, contrary to what the IRS asserted, no 20% accuracy-related penalty was appropriate, according to the Court, which found that the taxpayer made a reasonable attempt to comply with the law and acted in good faith.