Jointly owning a home encumbered by a mortgage with a non-spouse family member presents income tax reporting challenges and the potential for a deduction to be disallowed or challenged. A taxpayer’s home mortgage interest is generally deductible (within limits) if the taxpayer is the legal or equitable owner of the property. There is, however, no requirement that the taxpayer be liable on the loan (Reg. Sec. 1.163-1(b)).
In Qui Van Phan , TC Summary Opinion 2015-1 (Tax Ct.), the taxpayer’s mortgage interest deduction was allowed, despite the fact that he did not own the property and was not liable on the mortgage. The taxpayer successfully convinced the Tax Court to allow the deduction based on the following:
1. Taxpayer was under an oral agreement to purchase the property from his family members.
2. Taxpayer paid the mortgage, taxes, insurance, and other bills associated with the property.
3. Taxpayer maintained the property.
4. Taxpayer made improvements to the property.
5.Taxpayer provided clear and convincing evidence of the above facts.
The last point is key – no matter the ownership and bill paying arrangement, it is crucial that it be provable by clear and convincing evidence. Most challenges to the mortgage interest deduction take the form of a correspondence audit – basically, a letter from the IRS notifying you that your account has been changed and that you have a period of time to challenge the modification. When you receive these letters, you should contact a qualified tax professional immediately to write a letter back to the IRS documenting your ownership structure and bill paying arrangements. Although the tax savings generated from the mortgage interest deduction for that particular year being challenged may or may not be worth the cost of hiring a professional (depending upon the size of the deduction), the cost of forgoing the mortgage interest deduction for the life of the mortgage will almost always outweigh the cost.