Deducting Loan Interest on Shared Property

Together with my two sisters, I co-own the house where my parents are now living. There is a home-equity line on the house that all three of us had to co-sign on, which was used to pay for a new addition on the house and make it handicapped-accessible so my parents could live there. My understanding of publication 936 is that this is all (so far) considered acquisition debt, because it was used to substantially improve the home. Only two of us kids are in a position to pay the expenses at the moment, so I am splitting the loan payments with one of my sisters, who is currently living in the house with my parents.

My position is that each of us kids is jointly-and-severally liable for the whole amount of loan payments and property taxes, so we each get to deduct whatever is deductible that we actually pay (under the "second home" rules for me, and the "primary home" rules for my sister). So given that, if I'm paying half the interest (on an otherwise-qualified "second home"), I think I get to deduct that half of the interest, even if I only own a third of the house.

My Main Question: This year, my sister would like to pay the full amount of the loan payments directly to the bank and have me pay her back for half, instead of my paying the bank directly as I have been. Would that affect the deductibility, and if not, what records would we need to keep to support the deduction?

A secondary question: we anticipate drawing further on the home equity line later this year, in order to get the money to fix up and sell my parents' previous home, and perhaps to help provide for their upkeep. My understanding is that this extra money will be considered home equity debt, subject to the $100,000 limitation on the amount of home equity debt that has deductible interest. I believe this limit for me is $100,000 in total home equity debt (not counting any acquisition debt) between the home equity debt on this property and home equity debt on my primary home, while my sister gets her own $100,000 limit that is separate from mine. Or is this supposed to be a $100,000 limit for all home equity debt on a single property, regardless of how it gets split up?

For purposes of illustration, let's assume that I have $50,000 of home equity debt on my own home, and we borrow an additional $150,000 against the shared property for the purposes I mentioned above, which my one sister and I continue to split the interest on. Then my interpretation is that I could either deduct all of the interest I pay on the shared property ($75,000 in HE debt) and half the interest on my own loan ($25,000 out of $50,000), or I could deduct only 2/3 of the additional interest paid on the joint property ($50,000 out of $75,000 principal) and all the interest on my own loan. Presumably I would make that choice based on which loan had the higher interest rate. In either case, my sister could deduct all her share of the interest on the HE debt ($75,000 for her share of the principal), since she doesn't have another HE loan.

But if my interpretation is wrong, and the limit was $100,000 per property, then we would each only be able to deduct 2/3rds of the additional interest on the joint property. Which approach is correct?

Reply to
David Wallace
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Agree.

You have to create a formal loan note between you and her that says the loan is backed by your ownership of the home, and that if you default then she can foreclose on your ownership of the home. The note should spell out the interest rate, length/term, amount of loan (your half or third of the full original amount). This secondary loan should perhaps be recorded with the title company. The interest rate of the loan should be more than the AFR rate, but if the amount of the loan is less than 10k or 100k then special rules apply and the interest rate may be zero without triggering a gift tax.

I don't know. If it's true that it is 100k for each owner then it means that any house could be retitled to be owned by all family members and they could get hundred of thousands of dollar of equity loans among them all, with all of it deductible. Sounds like a loophole in the law.

Reply to
removeps-groups

According to removeps-groups :

I'm not sure that this works physically, even if we wanted to go this route. Where does the principal come from and go to to create this secondary loan? I was talking about paying against an original loan that has already been drawn and spent to pay the contractors. There aren't any pools of money sitting around unless we borrow more from the bank.

Also, the reason my sister wants to change the payment arrangements is that we do anticipate further draws and repayments this year against the line of credit, as described in my secondary question below. That will cause the monthly payments to vary quite a bit, so that splitting who pays which month, as we did last year, isn't as likely to make things come out about even. But trying to structure a separate secondary loan so that its payments go up and down along with the payments on the primary seems like it would be a lot more trouble than it's worth.

I don't think it would be much of a loophole, since people would still be limited to one second home each that had deductible interest, and if the $100K limit is not per dwelling, then it would definitely apply per taxpayer. In my first scenario, my sister and I between us would get $175K of deductible loans out of a total of $200K of borrowing. But we could have gotten a full $200K of deductible loans if instead of borrowing $150K against the shared property that we split, we had had her borrow an extra $100K against the shared property, which she solely made the payments on, while I borrowed an additional $50K against my primary property (in addition to the $50K I already had), and no one would question that. So we're not getting any overall tax benefit that we couldn't have gotten in a per-dwelling limit by restructuring the deal.

The main "loophole" that I see if the limit is per taxpayer rather than per dwelling, is that maybe a husband and wife could borrow $200K in deductible H.E. loans against their single primary residence by filing separately instead of jointly (unless something else prohibits this). But the disadvantages of filing MFS are strong enough that I don't think too many couples would take advantage of this. It would also be pretty unusual to have a MFJ limit that didn't get adjusted down for MFS.

Reply to
David Wallace

Your sister is a bank. By paying off the whole loan, she is essentially paying off her half and giving you a loan for your half.

That's the loophole. Is it per dwelling or per taxpayer?

The MFS is not valid. According to publication 936, each spouse gets only 50K when MFS.

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Reply to
remove ps

But she isn't "paying off the whole loan." She's only wanting to be the person who writes the check to the bank for the interest payments due this year, and she expects me to pay her for half of those every month. The amount of the principal that we both owe to the bank (with our other sister) is unchanged.

Your analysis would make more sense if she was repaying the principal to the bank out of her own funds (eliminating the loan) and then deferring me paying her back for half of that. But that's not what's happening here. The original loan is untouched, and we all still owe the full amount of the original principal to the bank. If she doesn't pay, the bank can come after me for the full amount owed, which I would have to pay to protect my interest in the house.

It seems that a close reading of pub 936 may have my answer:

More than one borrower.

If you and at least one other person (other than your spouse if you file a joint return) were liable for and paid interest on a mortgage that was for your home, and the other person received a Form 1098 showing the interest that was paid during the year, attach a statement to your return explaining this. Show how much of the interest each of you paid, and give the name and address of the person who received the form. Deduct your share of the interest on Schedule A (Form 1040), line 11, and print See attached next to the line. Also, deduct your share of any qualified mortgage insurance premiums on Schedule A (Form 1040), line 13.

Similarly, if you are the payer of record on a mortgage on which there are other borrowers entitled to a deduction for the interest shown on the Form 1098 you received, deduct only your share of the interest on Schedule A (Form 1040), line 10. Let each of the other borrowers know what his or her share is.

Given that passage, it sounds like all we have to do is come up with that statement of who paid how much of the overall interest, and attach it to each of our tax returns, along with a copy of the form 1098. So my paying her instead of the bank probably works, as long as we are both clear about who paid what.

Sounds like it's per taxpayer (or more precisely, per married couple). Again from Pub 936:

Home equity debt limit.

There is a limit on the amount of debt that can be treated as home equity debt. The total home equity debt on your main home and second home is limited to the smaller of:

$100,000 ($50,000 if married filing separately), or

The total of each home's fair market value (FMV) reduced (but not below zero) by the amount of its home acquisition debt and grandfathered debt.

Determine the FMV and the outstanding home acquisition and grandfathered debt for each home on the date that the last debt was secured by the home.

So for each taxpaying couple, the limit applies to the total on their main and second homes, which will generally be different than the main and second homes for their co-owners. The only limit mentioned per residence is the net FMV computation.

I think I have my answers now, but if anyone disagrees, let me know why.

Reply to
David Wallace

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