Dealing with a home mortgage interest deduction when the property is held by more than one person and those individuals are paying on the mortgage but not filing a joint income tax return creates issues when preparing the tax returns for those individuals. While taxpayers often believe the rule is “we can split it however we want,” Chief Counsel Advice 201451027 reminds us that there are rules that apply in these situations.
The deduction for home mortgage interest generally requires that a deduction be claimed by the person who paid the debt. While that rule sounds straightforward, in reality arrangements in such joint ownership/debt situations often introduce complications that make it unclear how the rule is to apply.
In this memorandum, the National Office counsel is responding to a request for clarification in three fact situations by IRS counsel in Denver. The requesting counsel in Denver specifically asked the National Office to analyze the situation in light of analysis found in PLR 5707309730A and the case of Neracher v. Commissioner, 32 B.T.A. 236 (1935).
The memorandum describes the holding in the cited PLR as follows:
PLR 5707309730A took the position in an instance where a husband and wife were filing separate returns, that when funds were paid from a joint bank account owned by both spouses for medical and dental expenses, each spouse was considered to have paid one half of the amounts paid from the account. The ruling states, “Where [taxpayers] maintain a joint checking account in which each apparently has an identical interest with the other, there is a presumption that items paid from such account are paid equally by each of the two parties.”
PLR 5707309730 cites Mark B. Higgins v. Commissioner, 16 T.C. 140 (1951), where a husband was allowed to deduct only one half of the interest paid from a joint bank account on a mortgage on property held by the husband and his wife as tenants by the entirety. In Higgins, rental income relating to the property was deposited into the joint account, and the husband wrote a check on the account to pay the interest. The court determined that he was not entitled to deduct all the interest on his separate return because he had not established that the interest was paid from his separate funds.
The memorandum goes on to summarize the holding in the Neracher case as follows:
In Neracher v. Commissioner, 32 B.T.A. 236 (1935), a taxpayer paid all the interest on a mortgage on which he was a joint obligor although his wife owned the mortgaged property. The court ruled the taxpayer was entitled to deduct the entire amount of interest paid on his separate return. The court did not consider the issue of whether payment of the funds was from a separate account of the taxpayer.
Based on those holdings the memorandum looked at each of the following factual situations.
The first situation is detailed below:
Situation 1. Taxpayers are a married couple and are jointly and severally liable on a mortgage, but one spouse is deceased at the end of the taxable year and the bank issues a Form 1098 under the deceased spouse’s social security number. The surviving spouse files a separate return. Payment may be made from a joint account or from separate funds of either taxpayer.
The IRS gives the following analysis of how to handle the mortgage interest deduction in the year one spouse dies, providing:
In the year of death, if the surviving spouse files a separate return, the decedent’s return should include income and deductions to the time of death. In determining the amount of interest deductible on the decedent’s return, the principles discussed above regarding payment from joint or separate accounts, and joint liability should apply. For example, if the decedent paid interest from a joint account before death, the decedent’s return should reflect one-half of the interest paid from the joint account before the time of death, in the absence of evidence that the interest was paid from the decedent’s separate funds. In years following the year of death, the surviving spouse is entitled to the deduction for interest since the surviving spouse is liable on the note, assuming the surviving spouse makes the interest payments and all other requirements are met.
The next situation considers the case of an unmarried couple. The situation provides:
Situation 2. Taxpayers are an unmarried couple and are jointly and severally liable on a mortgage, and the bank either issues a Form 1098 under only one social security number, or both. One or both taxpayers claims the mortgage interest deduction on their individual returns. Payment may be made from a joint account or from separate funds of either taxpayer.
The memorandum provides the following way to handle the interest deduction in this case:
Since both taxpayers are liable on the mortgage both are entitled to claim the mortgage interest deduction to the extent of the mortgage interest paid by either taxpayer. If the mortgage interest is paid from separate funds, each taxpayer may claim the mortgage interest deduction paid from each one’s separate funds. If the mortgage interest is paid from a joint bank account in which each has an equal interest, under Rev. Rul. 59-66, it would be presumed that each has paid an equal amount absent evidence to the contrary.
Finally the memo looks at joint ownership by other combinations of relatives. That situations is outlined as follows:
Situation 3. Related persons co-own a house and are liable on a mortgage note. A bank may issue a Form 1098 under the name of one or both of the co-obligors. Each taxpayer claims 50% or 100% of the deduction. Payment may be made from a joint account or from separate funds of either taxpayer.
In that case, the memorandum proposes the following treatment:
In general, to claim an interest deduction it is necessary to be liable on the note. However, section 1.163-1(b) states that “Interest paid by the taxpayer on a mortgage upon real estate of which he is the legal or equitable owner, even though the taxpayer is not directly liable upon the bond or note secured by such mortgage, may be deducted as interest on his indebtedness.” Under several tax court cases, Uslu v. Commissioner, T.C. Memo. 1997-551 and Amundsen v. Commissioner, T.C. Memo. 1990-337 a taxpayer was permitted to deduct interest on indebtedness even though the taxpayer’s family member, such as a sibling, was liable on the indebtedness, rather than the taxpayer. In such a case the taxpayer must show that they are the equitable owner of the property based on all the facts and circumstances. In general, if co-owners of a house are both liable on a mortgage, each one may take a deduction for the amount each one pays subject to the limitations and requirements of section 163(h). Neracher v. Commissioner, supra.
Interestingly in this case, the memorandum deals with an issue that wasn’t raised in the fact pattern—what happens when the person actually living in the home and making the mortgage payments is not one of the relatives who is liable on the note. The ruling opens up the possibility of a deduction but reminds us that the person claiming equitable ownership must be able to show such ownership based on facts and circumstances. In general, the courts are going to look to see if such equitable ownership would be recognized by the applicable state courts (see the case of Puentes v. Commissioner, TC Memo 2014-224)
As well, the answer makes clear that any person claiming a deduction must also show that they actually paid the amount for which they are claiming a deduction.