How to do it

[erchess]

In 2010 a client decided to help her daughter out by letting the daughter give her 15K and assume the mortgage on a house in exchange for which the daughter will get the house. Mom went to a lawyer who drew up a contract of sale. There is a contract sales price which represents a loss compared to the price at which Mom bought the house. There is the down payment and there is a provision that if the daughter is more than 30 days late with a payment all previous payments become rent and the house reverts to the mother.

Given what the mother wanted to do would it not have been simpler to gift the house to the daughter and let her assume the mortgage and perhaps let the daughter gift 15K to her mother?

Given what actually happened how do I report this? The return is not complete yet but what I was going to do was an installment sale with a loss and therefore only the interest is taxable and it is washed out by deducting the interest on Sch A. This is what my client understood the lawyer to say should be done but I wonder if it's right. The client is paying on actually three mortgages counting this one but one is for a rental house so I would only be including two on Sch A. On the other hand I'm not sure how a home you are giving away or selling can be your second home.

[gboykin]

Was a new deed recorded? If so, she cannot take interest on Schedule A on a house she doesn't own.

Another situation where they want you to clean up a mess that they should have checked with you prior to the transaction.

[Gary2]

Was a new deed recorded? If so, she cannot take interest on Schedule A on a house she doesn't own.
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That would depend on whether or not the daughter is considered the beneficial owner of the home, which I believe is a question determined under local law.

[Gary2]

In 2010 a client decided to help her daughter out by letting the daughter give her 15K and assume the mortgage on a house in exchange for which the daughter will get the house. Mom went to a lawyer who drew up a contract of sale. There is a contract sales price which represents a loss compared to the price at which Mom bought the house. There is the down payment and there is a provision that if the daughter is more than 30 days late with a payment all previous payments become rent and the house reverts to the mother.

Do you really mean the daughter paid the 15K as a down payment?

Given what the mother wanted to do would it not have been simpler to gift the house to the daughter and let her assume the mortgage and perhaps let the daughter gift 15K to her mother?

If you totally separate the two transactions, then you're talking about two gift tax returns, one for the mother giving the house to the daughter and one for the daughter giving the 15K to the mother. I don't see a problem with the mother selling the house to the daughter, though there's the question of fair market value. I'd suggest having the client spend a couple of hundred on a professional appraisal. (Obviously you don't hold up the return for that - it's for future use.)

Also, the conversion to rent creates some interesting tax questions. Check out the special rules for repossession of real estate.

Given what actually happened how do I report this? The return is not complete yet but what I was going to do was an installment sale with a loss and therefore only the interest is taxable and it is washed out by deducting the interest on Sch A. This is what my client understood the lawyer to say should be done but I wonder if it's right. ... On the other hand I'm not sure how a home you are giving away or selling can be your second home.

First, you can't do an installment sale on a loss. It's a sale at a loss coupled with interest income.

Second, if the daughter has legally assumed the mortgage, then it's not an installment sale. The mother was paid full price when the mortgage was transferred. But it sounds like you really mean that the daughter is making the payments, but the home and mortgage remains in the mother's name.

[erchess]

Clarification

Title and name on mortgage are still in the mother's name. Mom is making the mortgage payments and being reimbursed by daughter. Title will pass to daughter per contract when the last mortgage payment has been made.

Thank you for the clarification that you can't have a loss on an Installment Sale. I assume that we're talking about a Sch D transaction and a listing of interest on Sch B.

[JG EA]

Title and name on mortgage are still in the mother's name. Mom is making the mortgage payments and being reimbursed by daughter. Title will pass to daughter per contract when the last mortgage payment has been made.

Thank you for the clarification that you can't have a loss on an Installment Sale. I assume that we're talking about a Sch D transaction and a listing of interest on Sch B.

Prossibly not a loss. An installment sale contract is a transfer of ownership, the mom becomes the bank. The deed transfers when paid off just like at a bank. But, if the Mom sold it for less than FMV it may not be a loss. Ask for the paperwork. There may be a gift equity involved.

Not taking a loss on an installment sale is only the tax issue. There can still be an installment sale contract. If there is the daughter "owns" it in the same sense that she would through a bank loan.

Note what Gary said:

You said there was a contract and yet you say the Mom stills owns and is still making the morgage payments? This doesn't sould at all right. I would read that original contract and see just what it is.
If you totally separate the two transactions, then you're talking about two gift tax returns, one for the mother giving the house to the daughter and one for the daughter giving the 15K to the mother. I don't see a problem with the mother selling the house to the daughter, though there's the question of fair market value. I'd suggest having the client spend a couple of hundred on a professional appraisal. (Obviously you don't hold up the return for that - it's for future use.)

[erchess]

Contract and loss

First of all, it occurs to me that I failed to announce one very important point. The sale of the home to the daughter was in some previous year for which the mother did not file but for which she has engaged me to prepare returns. I'm not even sure at this point how long it has been since she filed. Her husband has been filing MFS since he married her but in 2010 he took responsibility for organizing her papers to the point I am preparing a joint return. He is also going through her papers year by year (she apparently kept everything she got that pertained to money) and getting me what I need. The IRS has not bugged her for reasons I am not clear on. All I know is the agent at PPL couldn't find anything on her for any open year but he suggested I file any returns that should have been filed for years going back to 2000 but please not any earlier.

I did read the contract. It is not even one page long. It specifies that:

the daughter will pay to the mother a lump sum of $15,000 that happens to be equal to what the mother put down when she took out the mortgage;

that the daughter and her family will occupy the home and the daughter will be responsible for all repairs and maintenance and for the insurance payment;

that the daughter will make monthly payments to the mother equal to the mortgage payment and that if any payment is over 30 days late the previous payments will be recharacterized as rent and the mother may at her option evict the family and will in any event continue to own the house;

and that until the last mortgage payment has been made the mother is the owner of the house but that at that point title will transfer to the daughter.

The mother believes that she bought and sold the house for its FMV at the time. She has significant experience in real estate valuation. Every three to five years the lady used to buy a property and she and her husband fix it up if needed and she sometimes rents it out for a few years but eventually she would sell it at a gain. The recession and accompanying crash in housing values caught her buying this house right at the peak of the local market. She's not an expert at picking when crashes will come but she's an expert in determining what a house can bring in any given market.

I'm willing to listen to contrary opinions but if I had to file the return right now I would report the mortgage interest paid by the daughter on Sch B and the same figure paid by the mother on Sch A. When I get around to filing the return for the year of sale I will report it on Sch D unless someone can persuade me that an installment sale at a loss can be done or that the loss was not legit. It will be hard to convince me of the latter.

[Gary2]

I still worry about the idea of recharacterizing the payments as rent. Is that even legal in that state? Usually there are landlord tenant laws that largely work to protect tenants; classifying something as not rental and then as rental might be seen as subverting those laws.

What happens if the mother invokes this provision ten years from now? Will the mother amend ten years worth of tax returns to add the rental income (in the year received, since presumably she's cash basis)? Along with any additional rental deductions? Are the mortgage payments are high enough to qualify as market-rate rents?

I've never done an actual installment sale nor a rent-to-own situation, but my understanding was that the only two (standard) choices are a) installment sale with a possible repossession (for which, if done right, results in just a basis reduction with no income); or b) rent-to-own in which all the income is taken as rental, but treated as a price reduction when the sale is finally done. This approach sounds like it's part of the "full employment for attorneys" program.

Was this contract drafted by an attorney?

[FEDUKE404]

This is a MESS!

I have read the posts on this thread twice - and my head is still spinning.

If I understand it correctly, the MOM still retains title and the mortgage is also in her name only.

Apparently the daughter is paying the mom funds that she then "transfers" to the mortgage company?

So who is paying the property taxes?

Absent transfer of property ownership and/or mortgage ownership, I fail to see how the daughter is gaining anything here. Surely she is not (legally) deducting either mortgage interest or property tax bills?

It almost sounds as if the mom came up with a creative way to NOT call rental income rental income, in addition to having daughter pay some (most) of mom's expenses for the house.

I don't (yet) see any sale here, which would eliminate installment sale issues. The clearest picture I can envision is a quasi-rental situation that the mom cooked up. If so, then you have to start at least considering depreciation (allowed or allowable). If mom is/was somehow treating this as a second home, then there are other issues there that could be on thin ice.

BTW: Was mom perhaps running into passive loss issues???? And just created an end run instead?

Soooooooo....what is the daughter showing on her own tax return? My prediction is all property taxes and all mortgage interest that, in reality, likely still belong to mom.

And then the flip side - if MOM is deducting same, somewhere along the way there would arise the issue of whether mom really "paid" those in the first place. And about those gift tax issues?!?

FE

[S T]

Agree

With FeDuke

This is a mess and one wonder's where to Start! I thought I had some issues with a few of my clients

Installment Sale at a Loss - I don't believe so - then don't you also have to look at some related party rules on Installment Sales

Was this a sale??? $ 15,000 sounds like a gift based on the outline or a VERY large Security Deposit- Mother is still on the Loan - daughter didn't assume - she is just paying Mother - so Mother can pay the lender.

Appears Mother still owns property and should be reported as a Rental on Sched E - monthly income - (and payment of property tax, insurance, repairs ???)

Not sure how to treat the $ 15,000?

AND What Attorney drew up this document? Seems creative

Sandy

[Davc]

It might be a land contract or contract for deed which are recognized as sales by the IRS.

[erchess]

Further clarification

Strange situations seem to find me. This is by far not the strangest I have encountered. Some people believe in the law of attraction which says that you attract people and events like yourself. There may be something to this concept.

The contract was drawn up by a lawyer. Even he admits it is creative but he says it is a common way for lenders to rip off people by giving them mortgages they in no way can afford and then taking the house. I have found out that there is only a year or two left on the mortgage. The lady has always shown profit on her rental activities and besides this property was never rented to anyone. The daughter is a client and she's not deducting anything relative to her home. (My business grows mostly by word of mouth so most of my clients are related to or close friends with other clients.) The truth is that the mother would never take the action the contract allows against her daughter so there is in truth no risk of needing to go back and amend returns over this issue.

The mother's intent in doing what she did was to allow her daughter to become a home owner at no net cost to Mom. I still think there was a better way to get to that point but oh well. I think I would be practicing law if I went against a signed contract prepared by a lawyer.

[Gary2]

The mother's intent in doing what she did was to allow her daughter to become a home owner at no net cost to Mom. I still think there was a better way to get to that point but oh well. I think I would be practicing law if I went against a signed contract prepared by a lawyer.

I don't think it's practicing law to tell someone that they can't claim a dependent even though the divorce decree, drafted by attorneys and signed by a judge says they can.

But in this case, it doesn't sound like the contract gives you enough information to determine the tax treatment. You need to know when the daughter became the beneficial owner under state law (which is not necessarily the same as the owner of record).