Who's deduction?

[AccTaxMan]

Father and son each owns 50% of their home.

Father paid for 100% of the mortgage interest and the property tax. Son paid nothing.

(1) Father claims 100% of the mortgage interest and property tax itemized deduction. Son claims none
.
(2) Father claims 50% of the mortgage interest and property tax itemized deduction. Son claims the other 50%. Father should file a gift tax return on the 50% mortgage interest and property tax payments that he paid for his son (if the total annual amount is more than $13,000).

(1) or (2)? Which is correct?

[Koss]

Was it really a gift?

I'm not sure the second option would fly in an audit, or in court.

What's bothering me is precisely the fact that without some sort of paper trail, or other evidence, it is difficult to ascertain whether the father's payments were intended as a gift to the son.

The underlying issue drifts into some very complicated areas of real property law. I'm not an attorney. But you started your post by asserting that each person owns 50% of the home. That may be true. It may not be true. When a father and son, or husband and wife, own a home as joint tenants with right of survivorship, this isn't exactly the same thing as each one owning 50%. It is a very subtle legal concept, and the exact details may vary from state to state. But lawyers will tell you JTWROS means that each person somehow owns the whole thing. Or that they own equal shares of the asset, even if their contributions, or bases are different. And that each person has the right to possession and use of the whole thing, not just some percentage of it.

And this very complicated idea ties right into the mortgage and property taxes. Who signed the mortgage note? Even when there are multiple owners, it is possible for one person to borrow against the property without the others getting involved in the loan. If it is done that way, then only the individual borrower is required to pay back the loan, but the entire property is usually put up as collateral--not just the "share" of the individual borrower. But sometimes it doesn't work that way. Sometimes only the individual borrower's share is security. In other cases, all of the owners sign the note, and they are jointly and severally liable, meaning that if one owner dies or disappears, the other owners are liable for the entire loan--not just "their share."

So this is what bothers me about the gift approach. The father and son you describe are probably joint tenants with right of survivorship. And let's assume, for the moment, that they both signed the mortgage note. This means that if the son doesn't pay "his share" of the mortgage and property tax, the father is liable for the entire amount, and vice versa.

So how do you show that it was a gift? The father may have paid the entire amount because his son failed to pay, leaving the father legally obligated to pay. The fact that the father paid the whole thing doesn't mean that he paid "his son's share." He paid something that he was legally obligated to pay himself. The fact that someone else was also obligated to pay doesn't transform it into a gift.

Now, see, if the father had written the son a check...

Then the son could have done anything he wanted with that money. If the son then chooses to use that money to pay part of the mortgage and property tax, it is much clearer that the money was a gift from his father, precisely because the son could have spent the money on something else, or just left it sitting in his bank account, and the father still would have been legally liable to make the entire mortgage payment...

The gift concept might fly if there was some sort of written contract between the two...

Or if the fact pattern is different from some of the assumptions I made.

BMK

[Koss]

Gift... or not?

If I haven't totally lost you on that rambling analysis...

Try a Google search on Crummey Power. It's a very similar concept that arises in irrevocable life insurance trusts. The grantor and the beneficiary are NOT the same person. These are NOT grantor trusts. The trust owns life insurance on the grantor's life, and the beneficiaries are usually his adult children, or grandchildren, or nieces, etc.

So the grantor, during his lifetime, has to pump money into the so that the trust can pay the life insurance premiums. But in order for the trust to work properly as an estate planning tool and asset protection vehicle, any money that flows into the trust must be available to the beneficiaries, at least for a certain period of time. The beneficiaries must have the right to pull that money out, before the life insurance premium is paid.

Hopefully they won't do that, because then the life insurance premium wouldn't get paid, and the policy would lapse, which defeats the purpose of the trust. But the terms of trust must allow the beneficiaries to get to that money, and they have to be given notice that it is available before the insurance premium is paid. Otherwise the entire trust fails, because the grantor is retaining too much control, and it becomes a grantor trust.

BMK

BMK

[AccTaxMan]

I'm not sure the second option would fly in an audit, or in court.

What's bothering me is precisely the fact that without some sort of paper trail, or other evidence, it is difficult to ascertain whether the father's payments were intended as a gift to the son.

The underlying issue drifts into some very complicated areas of real property law. I'm not an attorney. But you started your post by asserting that each person owns 50% of the home. That may be true. It may not be true. When a father and son, or husband and wife, own a home as joint tenants with right of survivorship, this isn't exactly the same thing as each one owning 50%. It is a very subtle legal concept, and the exact details may vary from state to state. But lawyers will tell you JTWROS means that each person somehow owns the whole thing. Or that they own equal shares of the asset, even if their contributions, or bases are different. And that each person has the right to possession and use of the whole thing, not just some percentage of it.

And this very complicated idea ties right into the mortgage and property taxes. Who signed the mortgage note? Even when there are multiple owners, it is possible for one person to borrow against the property without the others getting involved in the loan. If it is done that way, then only the individual borrower is required to pay back the loan, but the entire property is usually put up as collateral--not just the "share" of the individual borrower. But sometimes it doesn't work that way. Sometimes only the individual borrower's share is security. In other cases, all of the owners sign the note, and they are jointly and severally liable, meaning that if one owner dies or disappears, the other owners are liable for the entire loan--not just "their share."

So this is what bothers me about the gift approach. The father and son you describe are probably joint tenants with right of survivorship. And let's assume, for the moment, that they both signed the mortgage note. This means that if the son doesn't pay "his share" of the mortgage and property tax, the father is liable for the entire amount, and vice versa.

So how do you show that it was a gift? The father may have paid the entire amount because his son failed to pay, leaving the father legally obligated to pay. The fact that the father paid the whole thing doesn't mean that he paid "his son's share." He paid something that he was legally obligated to pay himself. The fact that someone else was also obligated to pay doesn't transform it into a gift.

Now, see, if the father had written the son a check...

Then the son could have done anything he wanted with that money. If the son then chooses to use that money to pay part of the mortgage and property tax, it is much clearer that the money was a gift from his father, precisely because the son could have spent the money on something else, or just left it sitting in his bank account, and the father still would have been legally liable to make the entire mortgage payment...

The gift concept might fly if there was some sort of written contract between the two...

Or if the fact pattern is different from some of the assumptions I made.

BMK

Thank you for your reply, Koss.

Ok, let's forget about the gift approach then.

If the father claims the full amount of the deduction based on the fact that he has paid the full amount of the expenses, will the IRS have problem with it since his ownership of the property is 50% only?

[Gary2]

Thank you for your reply, Koss.

Ok, let's forget about the gift approach then.

If the father claims the full amount of the deduction based on the fact that he has paid the full amount of the expenses, will the IRS have problem with it since his ownership of the property is 50% only?

Is father legally liable for the full amount? Or does the father stand to lose his share if the amounts aren't paid? Usually the answer is yes, so usually the father can take the deduction.

As for letting the son take any of the deductions, let me see if I have this correct: If the son was liable for any of the mortgage, then the option of having the son treat the interest as a deduction is valid, along with the father treating it as a gift. There's no requirement that you be the one to make the mortgage payments. However, for the real estate taxes, the son must actually have made the payment - unless there's some interpretation of local law that would allow a conclusion that there was a gift of the tax by father to son when the father made the payment.

The principal on the mortgage is only a gift if the son somehow had liability. If the father had bought the entire property himself, and somehow convinced the lender to add his son to the deed without also adding him to the mortgage, then the gift took place when the father gave the half-interest to his son. Treating the principal payments as a gift would result in double taxation.

[Koss]

AcctTaxMan wrote:

If the father claims the full amount of the deduction based on the fact that he has paid the full amount of the expenses, will the IRS have problem with it since his ownership of the property is 50% only?

Generally, the answer is no, the IRS will not have a problem with the father claiming all of the mortgage interest and property tax, based on the fact that he actually paid it.

I am still assuming that the father and son own the property as joint tenants with right of survivorship, and that the father is legally obligated to pay the entire amount of the mortgage, and all property taxes, if his son fails to pay any of it.

If the ownership form was different, for example, if the property was owned by two unrelated people as an investment, or if other facts were different, for example, if the father was not a borrower on the mortgage note, then my answer would be different.

I'm not sure I'm following everything Gary2 has said above, but I think we are reaching the same conclusion.

BMK

[appelman]

Generally, in such cases,

I believe that mortgage interest and taxes are claimed by the person who pays them, unless he has a right to claim reimbursement from the other party.

[ttbtaxes]

Rev. Rul. 71-268

Take a look at Rev. Rul. 71-268 which addresses this issue with respect to husband and wife, in a non-community property state, during divorce. The person who pays the expense is the one who gets to deduct it.

I think the tax results will be the same with father and son.

[OtisMozzetti]

under the radar reimbursements

I believe that mortgage interest and taxes are claimed by the person who pays them, unless he has a right to claim reimbursement from the other party.

The trouble with allowing whomever writes a check for mortgage interest and taxes to claim a Sch. A deduction is that it props the door wide open for cooperating parties to transfer that deduction from someone taking a standard deduction (or getting little benefit from the deduction) to someone else getting more tax reduction benefit from it. What I describe as cooperating parties might never reveal their actual arrangements, such as "I pay the mortgage, you pay the groceries", or similar, to the IRS.

[Gary2]

Take a look at Rev. Rul. 71-268 which addresses this issue with respect to husband and wife, in a non-community property state, during divorce. The person who pays the expense is the one who gets to deduct it.

I think the tax results will be the same with father and son.

That's a relatively simple ruling that relies on the liability of each party, without getting into deeper issues. It does address the question that some people have concerning the percentage of ownership (assuming that it's joint ownership in this father and son case). However, I don't believe the ruling must be read as disallowing other approaches if the circumstances justify it (e.g. if it's really intended as a part-gift to the other party).

[Gary2]

The trouble with allowing whomever writes a check for mortgage interest and taxes to claim a Sch. A deduction is that it props the door wide open for cooperating parties to transfer that deduction from someone taking a standard deduction (or getting little benefit from the deduction) to someone else getting more tax reduction benefit from it. What I describe as cooperating parties might never reveal their actual arrangements, such as "I pay the mortgage, you pay the groceries", or similar, to the IRS.

There's nothing wrong with that.

For better or worse, the tax code and regulations frequently pays attention to the details of who actually pays what. In the case of an unmarried couple with one child trying to control who claims HoH, it's perfectly fair to advise them to have one person pay the household expenses while the other pays the non-household expenses. With a college student who is borderline close to supporting himself, the parents can agree to buy the car if the student puts his earnings into savings or an IRA.

On the other hand, there is a problem when one party isn't eligible to take the mortgage interest deduction (e.g. they're over the mortgage limits, or it would be a third home).

[JohnH]

Sounds like good tax planning to me.

[ttbtaxes]

That's a relatively simple ruling that relies on the liability of each party, without getting into deeper issues. It does address the question that some people have concerning the percentage of ownership (assuming that it's joint ownership in this father and son case). However, I don't believe the ruling must be read as disallowing other approaches if the circumstances justify it (e.g. if it's really intended as a part-gift to the other party).

I agree that non-adverse parties can treat the transaction as a gift and allocate the deductions based upon that. In that case, they better have their documents completed, and in order, if they want to safely stray from Rev. Rul.71-268.