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DEDUCTING MORTGAGE INTEREST - UNMARRIED CO-OWNERS


Here is a real-life tax situation I was recently asked about -

A retired taxpayer lives in South Carolina and his adult son lives and works in California. The son wants to purchase a personal residence in California worth $1.3 Million but needs the help of his Father with both the down-payment on the property and the monthly Mortgage payments. The purchase mortgage principal will be $1.1 Million. Title to the residence will be held in the name of the son and the father jointly and both will be named on the purchase mortgage – but only the son will actually live in the property. The property will be the primary personal residence of the son – but not the father. The son will pay 75% of the monthly mortgage payment and the father will pay 25%.

I was asked to answer two questions -

(1) Can the California property be considered a “qualified second residence” of the father for purposes of deducting acquisition debt mortgage interest on his Schedule A or is it treated as an “investment property” with the applicable mortgage interest deducted by the father as investment interest, subject to the investment income limitation? 

(2) If the property is considered a qualified second residence of the father how much of the interest paid by the father can he deduct on Schedule A.

Taxpayers who itemize on Schedule A can deduct interest paid on “acquisition debt” - debt used to buy, build, or substantially improve a main residence or a qualified second home. A “substantial improvement” is one that adds value to the home, prolongs the home’s useful life, or adapts the home to new uses.

In order to qualify for the deduction -

* The home must be the owner’s personal residence (primary or secondary).

* The home must be used as the security for the loan.

* If the homeowner defaults on the loan the home will be taken to “satisfy” the debt.

* The loan must be recorded with the appropriate agency under state law, usually at the county level.

Qualified residence interest can only be deducted if you have an ownership interest in the home, you are legally obligated to pay the mortgage debt, and you actually make payments on the debt.

When two people buy a home together, and both owners are named on the mortgage, each owner can deduct the amount of interest he or she actually pays. If you pay 25% of the mortgage payment you can deduct 25% of the interest.   If you pay 50% of the mortgage payment you can deduct 50% of the interest.  If you own a home with a partner, but pay the entire mortgage payment each month you can deduct 100% of the mortgage interest on your Schedule A.

For mortgage loans on new home purchases incurred after December 15, 2017, you can deduct the interest on up to $750,000 in principal ($375,000 if Married Filing Separately).  Qualified debt cannot exceed the cost of the home and any substantial improvements. 

The principal limitation applies to unmarried co-owners of a qualified residence on a per-taxpayer basis and not a per property basis.   Each individual unmarried co-owner can deduct mortgage interest on up to $750,000 (or $1 Million) of acquisition debt.  So, an unmarried couple who jointly purchase a property in 2022 with a mortgage of $1,500,000 can each deduct 50% of the total interest paid on the property, assuming they each pay half of the monthly mortgage payment, and even though the loan principal exceeds $750,000.      

Also deductible on Schedule A is “investment interest” - interest that is paid on loan proceeds used to purchase taxable investments or securities.  Real estate is an investment.  The deduction is limited to the taxpayer’s “net investment income” – taxable interest, “non-qualified” dividends, net short-term capital gains, royalties, and annuities less deductible investment expense (obviously not including investment interest).  Qualified dividends and long-term capital gains can be included in investment income if the taxpayer elects not to tax this income at the special lower capital gain rates.  Excess investment interest (investment interest paid that is not deductible on the current return) can be carried forward and deducted on future returns, subject to the net investment income exclusion.

In our scenario the father is not charging his son any fair market rent for his ownership interest, so the father is considered to be using the home for personal purposes and it can be treated as a qualified second home of the father for purposes of claiming a mortgage interest deduction.

And since the principal limitation if per taxpayer and not per property, and the father is named on the mortgage, the father can deduct the full amount of mortgage interest he pays.  If the total interest for the year is $10,000 and the father paid 25% of each monthly mortgage payment paid from his funds, he can deduct $2,500 as mortgage interest on his Schedule A.

I have written a special report on “Deducting Mortgage Interest” that discusses in detail all the rules and regulations for the Schedule A mortgage interest deduction.  It emphasizes the vital importance of keeping separate track of “acquisition debt” and “home equity debt” and provides a detailed example and worksheets for you to use.  The cost is only $2.00.

It is my firm belief that more often than not taxpayers who itemize are deducting the wrong amount of mortgage interest – either too much or too little.  Every single homeowner with a mortgage who itemizes on their federal tax return needs to purchase and read this report.

To order your copy of this report send a check or money order for $2.00 – payable to Taxes and Accounting, Inc – and a SASE to –


DEDUCTING MORTGAGE INTEREST
TAXES AND ACCOUNTING INC
POST OFFICE BOX A
HAWLEY PA 18428 

TTFN 













This post first appeared on THE WANDERING TAX PRO, please read the originial post: here

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DEDUCTING MORTGAGE INTEREST - UNMARRIED CO-OWNERS

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