RE taxes & mort interest on 2nd home with sister

[Bees Knees]

The "must be FMV" rule is under IRC 280A, which is the provision stating how to allocate expenses on mixed-use property (part rental, part personal). Under the general rule, renting to a family member is considered personal use, and those days can't be counted in allocating expenses. The FMV rule just says that if you get FMV rent, you get to count those days as rental and you won't be penalized because your tenant happens to be a relative.

Maybe, maybe not. Yes the FMV rule is found under IRC Section 280A(d)(3) and applies to whether or not the unit is used for personal purposes in relation to the limitation on deducting expenses in excess of rental income.

However, the home mortgage interest rules are found in IRC Section 163(h)(3) and the qualified residence definition (of a 1st or 2nd home) is found at Section 163(h)(4)(A) which says:

(4) Other definitions and special rules

For purposes of this subsection--

(A) Qualified residence

(i) In general, the term ``qualified residence'' means--

(I) the principal residence (within the meaning of section 121) of the taxpayer, and

(II) 1 other residence of the taxpayer which is selected by the taxpayer for purposes of this subsection for the taxable year and which is used by the taxpayer as a residence (within the meaning of section 280A(d)(1)).

Note that the second home can be selected by the taxpayer, in the case where the taxpayer owns more than 2 homes. It also mentions the taxpayer using it as a residence within the meaning of section 280A(d)(1) which is the same code section that has a FMV rental rule attached to it. The FMV rental rule may not have been specifically mentioned in code section 163, but I can see where an argument can be made that says it applies.

On the other hand, the FMV rental rule of Section 280A is irrelevant to co-owners. That rule only talks about renting at FMV to a person for use as that person’s principal residence. Since the sister is a co-owner, she cannot pay rent for its use since rent is defined as paying for the use of property you do not own. Since she owns it, she cannot also be renting it. So my conclusion is the FMV rental rule is irrelevant in this case since the sister is a co-owner and cannot be expected to pay FMV rent for her use of the property.

[Luis Mopeo]

Since use by a related party that is not paying FMV rent makes it personal use property, I'd say that is a good argument for second home treatment.

I don't believe that rule applies.

The "must be FMV" rule is under IRC 280A, which is the provision stating how to allocate expenses on mixed-use property (part rental, part personal). Under the general rule, renting to a family member is considered personal use, and those days can't be counted in allocating expenses. The FMV rule just says that if you get FMV rent, you get to count those days as rental and you won't be penalized because your tenant happens to be a relative.

Just renting to a relative for less than FMV doesn't automatically make it personal use. It just means you can't deduct the expenses attributable to that period.

[JAinNC]

I was ready to disagree but

then I read the first post to this thread again. It does seem that his intent was to help his sister buy a home.

[joanmcq]

Since use by a related party that is not paying FMV rent makes it personal use property, I'd say that is a good argument for second home treatment.

[Bees Knees]

Point of clarification on 2nd home issue:

Just because interest is reported on a 1098, that does not automatically give you deductible interest. The interest tracing rules apply, unless it is a 1st or 2nd home, used as a 1st or 2nd home. An example would be rental property. You take out an equity loan on your rental house to buy a car. The mortgage company issues you a 1098 for interest paid. The interest is non-deductible because under the interest tracing rules, you did not use the loan proceeds in your rental activity. It would be irrelevant whether or not you already own 2 homes or not, since the rental house is clearly not used by the taxpayer as a 2nd home.

That would be similar to this situation. If brother only owns one main principal residence, his sister’s house is not automatically his second home. A 2nd home has to be used as such. If it is truly his 2nd home, used as a 2nd home, then interest tracing rules do not apply. If it is not his 2nd home, then interest tracing rules apply and the deductibility of interest would have to fall under either business interest or investment interest, subject to the investment income limitation.

[Bees Knees]

The other consideration here is Section 121, if and when this house would be sold. If he owns the property and she lives in it, neither could claim the exclusion.

She could claim the exculsion if she was a co-owner. The fact that he is a co-owner does not affect her ability to exclude gain under Section 121.

[SunTaxMan]

Perspective

Your comment, "I'd consider it his second home," gives me concern. I think we, as Preparers, are on "thin ice" when we translate our perspectives to become the taxpayer's perspective, rather than focus on the taxpayer's intent in any situation, and use that as our starting point.

I think the primary consideration should be how the taxpayer views this "second home," i.e., does the taxpayer consider it a "home" for him, or is he helping his sister have a home?

In either case, the deduction for interest and RE taxes belongs to (1) the person who is legally liable for the debt AND (2) the person who is making the payments - whether that is 100%, 50/50%, 70/30% - apportionment based on "facts" of whose money/obligation is involved.

With these considerations in mind, "gifting" may be part of this situation.

Granted, within the economic limits of mortgage interest deductions, if he is making the payments, he can deduct the 1098 interest, but if (1) he is helping his sister have a home and (2) he decides he would like to buy a boat or motor home {that qualifies for 1098 interest}, he then might lose the deductibility of his sister's residence.

The other consideration here is Section 121, if and when this house would be sold. If he owns the property and she lives in it, neither could claim the exclusion.

[KJ Judd]

Sea-tax -

I thought, perhaps, the IRS would deem him to make a gift to his sister for her 1/2 of the real estate taxes since he didn't own the entire property and they are both liable for the taxes. However, I was hoping to hear what I'm seeing on the board. My client is in a much higher tax bracket than sister.

Kathy

[JAinNC]

Thanks

I have some situations that come up that are similar.It is good to have wise input from you guys.
Jeannie

[sea-tax]

And the Real estate taxes? I think he may be limited to 50% since they both own the house. However, he will be the only one paying the real estate taxes.

If he is the one paying 100% of the property taxes, then why would he not be able to take 100% of the deductions?

[Bees Knees]

I see that he has the right because the mortgage is in his name. The home is in both names. Does it matter that he doesn't own the entire home? If he owns one half, his half = 880K / 2 = 440K. After the down payments the mortgage balance = 670K. Can he still deduct the entire mortgage? Asking because I have calls from people who are planning to do something like this and want to know what is deductible. Every situation is a little different.

As Sandy said, acquisition debt=total acquisition debt on main and second home combined which is limited to $1million

The rule says nothing about ownership in FMV equity. It simply puts a limit on the amount of debt you can incur. If the home was worth 880K and he was a 50% owner, the 440K share of equity is irrelevant. He borrowed 670K to purchase his share of a home worth 880K. His acquisition debt of 670K is less than the 1 million limit. Assuming his 1st home doesn't put him over that 1 million limit, he should be able to deduct all of the interest paid.

[JAinNC]

Exactly my point.

[S T]

Another Issue

How much of Home mortgage interest paid will qualify as a deduction?

Secured Debt - includes loans secured by the taxpayer's main home or a second home

Acquistion Debt=total acquistion debt on main and second home combined which is limited to $1million

Then there is the equity debt that might not qualify as acquistion debt, which would equal to no more than $100,000 combined on primary or second home.

See TB page 4-11.

So you might still have some limitations on the deductions of your mortgage interest, if t/p is over the $1million + $100K

Sandy

[joanmcq]

The RE taxes are the same; he has to be a responsible party and pay the tax. If he pays 100%, he gets to deduct 100%. If they paid 50/50 they each get to deduct half.

[KJ Judd]

And the Real estate taxes? I think he may be limited to 50% since they both own the house. However, he will be the only one paying the real estate taxes.