Deducting Interest When You Are Not On The Title

Written by Posted On Tuesday, 27 January 2015 12:09

Question: I want to buy a condominium unit for my son. Although he makes a decent living, his credit is not good. Accordingly, the lender has advised that title must be in my name only. My son will live in the property and make all of the mortgage payments.

Can he deduct the mortgage interest on his tax returns?

Answer: The answer is a qualified yes. There are certain rules which you must follow since if the IRS ever challenges the deduction, the burden will be on your son to prove that he is eligible to take the deductions.

We must first look to the regulations which have been promulgated by the IRS.

Regulation 1.163-1(b) reads as follows:

Interest paid by the taxpayer on a mortgage upon real estate of which he is the legal or equitable owner, even though the taxpayer is not directly liable upon the bond or note secured by such mortgage, may be deducted as interest on his indebtedness.

In August of 2003, the United States Tax Court addressed this situation and denied the interest deduction. The petitioner bought a house for his mother and although the mortgage loan was not in his name, he made the monthly loan payments. He argued to the Tax Court that he was obligated to repay his mother and "that his failure to repay would result, upon his mother's death, in a corresponding reduction in his testamentary share of his mother's estate. But the tax court rejected this argument. Based on the facts which were presented in evidence, the Court determined that the petitioner was neither "directly liable on the note securing the mortgage on his mother's house, nor (was) he a legal or equitable owner of the property." (Montoya v IRS, decided August 5, 2003.)

However, this same Tax Court held -- as recently as January 12, 2015 -- that the son was an equitable owner. In Phan v. IRS (Docket 16202-13S), the court was impressed with the fact that the son's family had granted him an interest in the property and would allow him to add his name to the title if he paid the property expenses.

What exactly is required to be an "equitable owner"? Our legal dictionaries define this as ownership by one who does not have legal title.

Let's look at this example. I own property A; I am the legal title holder to the property. I enter into a contract to sell the property to you. Based on that contract, even though you have not yet taken title, you have certain rights. These rights are based on the legal principles called "equity" -- namely that the courts will do what is fair under the circumstances, rather than strictly interpreting the letter of the law.

Obviously, each case has to be decided on the specific facts presented to the Court. In the Montoya case, the Tax Court determined that the son just did not have enough evidence to prove that he had some kind of ownership in his mother's property. But in Phan, the son's testimony convinced the court and the son was allowed to deduct the mortgage interest on the mortgage payments he was making. Unfortunately, the opinion in Phan cannot be treated as precedent for any other case; however, the reasoning spelled out by the court will give taxpayers guidance.

Several years earlier, this same Tax Court also allow a couple to deduct the mortgage interest even though they were not on title to the property. In Uslu v IRS, the following facts were presented to the Court.

Uslu had filed for Chapter 7 Bankruptcy relief and was not eligible to obtain a mortgage loan. His brother bought the house, in which the only occupants were Uslu and his wife.. The loan was in the brother's name only, but Uslu made all of the mortgage payments. He also made all of the repairs and improvements to the property. The brother signed a Quit Claim Deed conveying the property to Uslu, although this Deed was never recorded on the land records.

The Tax Court found that Uslu's mortgage payments "constituted payments on an indebtedness" and thus could be deducted for income tax purposes.

According to the Court:

The Court is satisfied, from all of the evidence presented, that petitioners (Uslu) have continuously treated the... property as if they were the owners, and that they exclusively, held the benefits and burdens of ownership threof. On this record, the Court holds that petitioners established equitable and beneficial ownership of the (property), and they were liable to (the brother) in respect of the mortgage indebtedness.

How do you meet the burden? Here are some suggestions:

  • your son must continuously live in the property. To prove this, his driver's license, voter registration and utility bills should be in his name at the property address;
  • you and your son should enter into a written agreement, spelling out that he is fully obligated to make the mortgage payments on a timely basis, and that you reserve the right to evict him should he go into default; the agreement should specifically state that you recognize that your son has an equitable interest in the property;
  • your son must be responsible for all maintenance and upkeep of the property, and
  • you should prepare and sign a Quit Claim Deed, in recordable form, conveying the property to your son. This will not be recorded, but will be further evidence of your decision that this property is, in reality if not legally, owned by your son.

There obviously are no guarantees, but if you follow the guidelines spelled out above, you have a good chance of prevailing should the IRS challenge your son's deductions.

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Benny L Kass

Author of the weekly Housing Counsel column with The Washington Post for nearly 30 years, Benny Kass is the senior partner with the Washington, DC law firm of KASS LEGAL GROUP, PLLC and a specialist in such real estate legal areas as commercial and residential financing, closings, foreclosures and workouts.

Mr. Kass is a Charter Member of the College of Community Association Attorneys, and has written extensively about community association issues. In addition, he is a life member of the National Conference of Commissioners on Uniform State Laws. In this capacity, he has been involved in the development of almost all of the Commission’s real estate laws, including the Uniform Common Interest Ownership Act which has been adopted in many states.

kasslegalgroup.com

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