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Deductible Mortgage Interest

NU
Level 3

Scenario

House was owned by Client 1 and Client 2's father.  In 2013, the father used a quitclaim deed to transfer ownership to clients 1 and 2.   After the change in ownership, the father still had a mortgage of  $150,000 on the house.  The father passed in 2016, and the mortgage remained in the estate's name.  In 2020, Sister 1 and Sister 2's husband took out a $300k mortgage ($125k to pay off the father's existing mortgage, $25k for some home improvements and $150k in the bank).  Sister 1, sister 2 and sister2's husband all live in the house as their main home (and have for years).  We know the basis for sister 1 and sister 2 is equal to the father's basis. 

Do you agree they are entitled to deduct  50% of the interest and points (loan orig) on the new mortgage?  $125k (acq from dad's mortgage and 25k improvements) / 300k new loan.    

Been going over this one for a while and wondering if anyone has thoughts? :😊

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6 Replies 6
jeffmcpa2010
Level 8

Who is paying the mortgage...If sister 2 is paying all of it, how would sister 1 be able to claim any of the interest?

(I don't necessarily know the answer - just throwing out ideas to think about.)

NU
Level 3

Hi @jeffmcpa2010  Thanks for throwing a thought out!  The new loan was taken out by sister 1 and the husband of sister 2.  They all live together in the house so they meet the main home requirements.  Sister 1 pays 50% of the mortgage and sister 2 and her husband (joint filers) pay 50% of the mortgage.   My thought is they can split the allowable mortgage interest (which per the example would be 50% of the overall interest).      

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jeffmcpa2010
Level 8

I can't argue with that since they both own the house 50/50 and make the payments 50/50.

It one of the ratio's was different I would have to think some more. (not sure someone could deduct something if they didn't pay it.)

NU
Level 3

@jeffmcpa2010  Given the rules about acquisition versus equity debt on the Federal side, do you agree with only 50% of the total interest being allowable--  125+25 = 150k of the 300k loan?     In other words since they paid off dad's acquisition loan, can they treat the 125k as their acquisition debt and add on the 25k in improvements? 

P.S.  has anyone ever heard of someone getting audited and asked to prove the acq versus equity? I have had some new clients over the years, and it seems like they have been taking 100% of the interest even when some of their loan is clearly tied to equity debt... 🤔

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jeffmcpa2010
Level 8

Not really well versed in that (acquisition vs equity) so I will leave that to some one else to help you with.

 

BobKamman
Level 13

How is the $125K "home acquisition indebtedness"?  The deceased father is the one who took out the mortgage, right?  Are you saying that just because they inherited the house, they inherited the characteristic of the mortgage being related to home acquisition?  What else did they inherit -- any cash?  Did Dad leave them $500K and they decided not to pay off his mortgage?  Is their basis less than the $125K, anyway?  Not that it might not make any difference.  

Why are you just getting around to asking now?  They did call you last year before they did this, right?

Here is the round hole of Code Section 163(h).  Try to pound your square peg into it:

(B)Acquisition indebtedness
(i)In general
The term “acquisition indebtedness” means any indebtedness which—
(I)is incurred in acquiring, constructing, or substantially improving any qualified residence of the taxpayer, and
(II)is secured by such residence.
 Such term also includes any indebtedness secured by such residence resulting from the refinancing of indebtedness meeting the requirements of the preceding sentence (or this sentence); but only to the extent the amount of the indebtedness resulting from such refinancing does not exceed the amount of the refinanced indebtedness.

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