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Can’t Get a Home Loan but Still Paying Someone’s Mortgage? Beware the Interest Deduction Rules

Posted on by Caleb Newquist
Here's the latest post from our new tax guy, Tony Nitti. See his first post on Robinson Cano kicking the New York Yankees to the curb and you can find him tweeting from @NittiGrittyTax. Tony wrote a similar post on this subject last March but current events called for a update. Enjoy. 
 
The lending market ain’t what it used to be. The free-wheeling days of the early part of the millennium — when banks were handing out cash faster than Stephen Hawking at a strip club — are long gone. The subsequent housing market crash has forced lenders to tighten their purse strings, leaving many hopeful homebuyers – read: you — unable to secure a mortgage.
 
Faced with the ultimate indignity of running back to mom and dad, you might decide to get creative. After all, you’ve got cash to burn, just no credit. 
 
So you find yourself a friend or sibling or craigslist serial killer with the opposite attributes: the credit necessary to have purchased a house in the past, but no cash to fund their current mortgage obligation. And you strike a deal: You’ll move in, share the place, and you’ll pay the mortgage. 
 
These increasingly common types of arrangements, while achieving the desired goal of providing a roof over your head, create confusion when it comes time to determine who is entitled to deduct the mortgage interest on their tax return. 
 
Fortunately, a mix of regulatory authority and judicial precedent provides the necessary guidance, but in order to determine who gets the deduction, you’ve got to work through a series of questions that may or may not yield the answer you want as the person parting with the cash.   
 
1. Who paid the mortgage? Because individuals are cash basis taxpayers, only the taxpayer who actually pays the mortgage is entitled to a deduction. So the homeowner is out. 
 
2. Who is listed as the borrower on the mortgage? In general, a taxpayer can’t deduct interest he pays on a debt that isn’t his.1 Thus, without some relief, you won’t be able to deduct the mortgage interest — even though you paid it — because you’re not listed as a co-borrower on the mortgage. 
 
3. Who has legal title to the house? Treas. Reg. §1.163-1(b) provides an exception to the general rule found in #2. Pursuant to the regulations, even if you’re not directly liable on the mortgage, you can deduct any interest you pay on the debt as long as you are the legal owner of the house (e.g., a deed holder). Unfortunately, this doesn’t help you in our scenario because you’re not listed on the deed. 
 
4. So then nobody is entitled to deduct the mortgage interest? Not so fast. The regulations also allow a taxpayer who is an “equitable” owner of the house to deduct the mortgage interest he pays, even if he is not listed on the mortgage as a co-borrower. 
 
What constitutes an “equitable” owner of a house?  The Tax Court has typically defined an equitable owner as one who:
  • Has a right to possess the property and to enjoy the use, rents or profits thereof;
  • Has a duty to maintain the property;
  • Is responsible for insuring the property;
  • Bears the property’s risk of loss;
  • Is obligated to pay the property’s taxes, assessments or charges;
  • Has the right to improve the property without the owner’s consent; and
  • Has the right to obtain legal title at any time by paying the balance of the purchase price.2
On Monday, the Tax Court examined just such a situation in Puentes v. Commissioner, T.C. Memo 2013-277. In Puentes, the taxpayer moved into a home owned by her brother. Her brother was the sole holder of legal title to the property, and the only obligor listed on the mortgage. Taxpayer, however, made the mortgage payments. 
 
In 2009, taxpayer’s brother received a Form 1098, Mortgage Interest Statement, reflecting $29,000 of interest expense paid during the year. Because taxpayer had actually paid the interest, she claimed the deduction on her tax return. 
 
The IRS denied the deduction because while the taxpayer had in fact paid the mortgage interest, she was neither the legal owner of the property nor was she listed as a debtor on the mortgage. 
 
Conceding these points, the taxpayer instead argued that she was the equitable owner of the house, and thus was entitled to the deduction pursuant to the Section 163 regulations. The Tax Court, however, was unconvinced. 
 
Because the taxpayer was not legally obligated to make the mortgage payments or pay any real estate taxes, had no duty to maintain or insure the property, and had no right to improve or purchase the property, the court concluded that she failed to establish that she was an equitable owner. As a result, her mortgage interest deduction was denied. 
 
If the decision in Puentes has left you wondering how you can ever be respected as an equitable owner of a home, here’s some advice: buck up for part of the down payment. Do that, and the courts have respected the fact that you have skin in the game and bear some portion of the risk of loss (factor #4), even if you’re not listed on the deed or mortgage. 
 
And that’s one to grow on. 
 
1 Golder v. Commissioner, 604 F.2d 34 (9th Cir. 1979). 
2 Blanche v. Commissioner, T.C. Memo 2001-63.
 

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Bill Clinton Wants a Lower Corporate Tax Rate

“We’ve got an uncompetitive rate,” Clinton told a crowd at the Aspen Ideas Festival on Saturday.

“We tax at 35 percent of income, although we only take about 23 percent. So we should cut the rate to 25 percent, or whatever’s competitive, and eliminate a lot of the deductions so that we still get a fair amount, and there’s not so much variance in what the corporations pay.” [HP]

Analysis: Corporations May Be People But They Are Definitely Not Humans

The Iowa State Fair is going strong and because Election 2012 is in full throttle, the GOP Presidential candidates have been posing for photo-ops and making statements with varying degrees of stupidity.

One of the most logical things uttered, I dare say, was done so by Mitt Romney. By now you’ve probably heard that ol’ Mitt, in between corndogs, got into a bit of a verbal joust with a few of the fair goers. Here’s the soundbite:

The statement has been examined and debated with most intelligent people coming down on the side of Romney. That is, human beings – whether it’s shareholders, employees or customers – eventually bear the cost of the taxes paid by corporations. So while a whole host of humans, including the majority Supreme Court of the United States, are stuck on this “people” thing, it’s worth noting (mostly for the sake of stupid fun) that corporations are definitely not “humans.” Maybe that’s overstating the obvious but English is complicated language and this exercise is not without its merits.

Humans, at their best, are capable of being compassionate, loving, generous and all that crap. Corporations are not. At worst, humans are disgusting, vile creatures capable of ridiculous behavior and we know this to be true mostly because of reality TV. Corporations are certainly capable of deplorable behavior but this behavior is usually at the behest of a human being’s decision.

Accordingly, let’s examine some thing that demonstrate that don’t make corporations “human.”

• Corporations don’t flash women who aren’t the age of consent.

• Corporations don’t use your bathroom and help themselves to the Goldbond Medicated Powder to an extent that you wonder if someone left the window open during a snowstorm.

• Corporations don’t eat corn dogs (humans shouldn’t either).

• Corporations can’t sign a taxpayer protection pledge.

• Corporations don’t “try out” 18 year-old women, take them over state lines and then take money in order to “protect” them.

Feel free to volunteer other examples of “human” versus “people” below but what’s important to note here is that while both humans and corporations may be people, all humans are people and it’s clear that corporations are not humans.

And if that still doesn’t help you understand the difference, just remember this – no matter the situation, for better or worse, humans are the ones who get screwed. Got it?

(UPDATE 2) News Corp. Appears to Be a Big Fan of Offshore Tax Havens

Sure, GE may have the “best tax law firm” in house but the boys and girls working for Rupes seem to have a few tricks of their own. David Cay Johnston reports:

News Corp. has 152 subsidiaries in tax havens, including 62 in the British Virgin Islands and 33 in the Caymans. Among the hundred largest U.S. companies, only Citigroup and Morgan Stanley have more tax haven subsidiaries than News Corp., a 2009 U.S. Government Accountability Office study found.

News Corp. had nearly $7 billion permanently invested offshore in 2009, money on which it does not have to pay taxes unless it brings the money back to the United States. Meanwhile, it can use that money as collateral for loans in the United States, where interest paid is a tax-deductible expense.

This and other tax planning strategies result in a 20% tax rate for the company. And not a single phone hacked!

[via Reuters]

UPDATE:
Via NPR’s The Two Way news blog, Reuters has posted this statement:

Please be advised that the David Cay Johnston column published on Tuesday stating that Rupert Murdoch’s U.S.-based News Corp made money on income taxes is wrong and has been withdrawn. News Corp’s filings show the company changed reporting conventions in its 2007 annual report when it reversed the way it showed positive and negative numbers. A new column correcting and explaining the error in more detail will be issued shortly.

As of now, Johnston’s post remains unchanged and what I blockquoted above doesn’t seem to be in dispute but the situation appears to be fluid.

UPDATE 2:
Here’s a portion from Johnston’s new column:

Readers, I apologize. The premise of my debut column for Reuters, on News Corp’s taxes, was wrong, 100 percent dead wrong.

Rupert Murdoch’s News Corp did not get a $4.8 billion tax refund for the past four years, as I reported. Instead, it paid that much in cash for corporate income taxes for the years 2007 through 2010 while earning pre-tax profits of $10.4 billion.

For the first time in my 45-year-old career I am writing a skinback. That is what journalists call a retraction of the premise of a piece, as in peeling back your skin and feeling the pain. I will do all I can to make sure everyone who has read or heard secondary reports based on my column also learns the facts and would appreciate the help of readers in that cause.

Johnston goes on to explain in detail how the error occurred. He also states that a number of the facts originally reported, including the number of News Corp. subsidiaries in tax haven (that we blockquoted above), remain.