Qualified home mortgage interest expenses are claimed as an itemized deduction under Schedule A of the Form 1040. Schedule A allows deductions of interest on loans of up to $1,000,000 and interest on home equity debt of up to $100,000. While this deduction is quite simple for many taxpayers, it has become a controversial issue among other taxpayers. Who will be allowed to take this deduction when someone other than the homeowner pays the mortgage? How much mortgage interest can unmarried co-owners take?
In many cases taxpayer A has made mortgage payments on behalf of the taxpayer B without having any debt obligations. Will taxpayer A be able to take the deduction on their Schedule A? It depends. State law will determine whether a taxpayer is an equitable owner of the property and the federal tax court will use this determination to decide on the deductibility of the interest. The IRS will disallow taxpayer A’s claim for a deduction unless he/she can prove that they are an equitable owner of the property. Although state law varies on the definition of equitable ownership, the following are general characteristics of an equitable owner:
- The right to possess or rent the property
- The right to improve and maintain the property
- The right to purchase the property
- Bears the risk of loss in the property
- Has a duty to pay all tax assessments
Keep in mind that many state courts will not consider a taxpayer an equitable owner until the taxpayer has been properly added to the deed and mortgage. Before making any payments on a mortgage for which you are not directly liable, consider whether you will be able to take a qualified interest deduction when filing your Schedule A, Form 1040.
Another important issue to consider when questioning whether a taxpayer can claim the qualified interest deduction is when unmarried co-owners are involved. One may say that taxpayer A and taxpayer B are each subject to the $1.1 million limitation. However, the IRS will consider this situation as a single $1.1 million limitation. Let us assume there is a $1.5 million debt owned by taxpayer A and B. Taxpayer A paid $30,000 of mortgage interest and taxpayer B paid $20,000. Taxpayer A and B are both filing single status returns. Each believes they can take the full mortgage interest as each is entitled to the limitation. However, the IRS will determine this loan by unmarried co-owners as subject to a single $1.1 million debt. Each taxpayer can only take 73% of the interest paid. This example is supported by the tax courts who agree with the position of the IRS as seen in Sophy v. Commissioner 138 T.C. 204 (2012) where the tax courts agreed that the unmarried co-owners were subject to a single $1.1 million limitation.
Although the mortgage interest deduction is one many take without second thought, it is important that all taxpayers consider their mortgage situation before claiming a deduction.