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 1.163-1b 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 mothers death, in a corresponding reduction in his testamentary share of his mothers 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 mothers 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 sons 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.
Lets 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 mothers property. But in Phan, the sons 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 >
The Tax Court found that Uslus 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:
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 sons deductions.
