The harsh economic environment, and stricter lending policies, have led many to fail to qualify for traditional lending. A popular solution has been to tap into the creditworthiness of parents or other family members, with the understanding that the occupant of the home will be responsible for the monthly mortgage payment. The question that arises from this arrangement is whether the mortgage interest expense can be deducted by the occupant of the home, even though he is not legally responsible for paying the mortgage.
Uslu, T.C. Memo. 1997-551, refers to a tax court case in which Saffat Uslu, who filed for bankruptcy, lived on a property financed and legally held by his brother. In 1992, he paid $18,980 in interest to the mortgage holder and claimed a deduction. The IRS disallowed the deduction on the premise that the taxpayer was not legally responsible for the property. The Tax Court, however, ruled in favor of Uslu, because of an important exception in the tax code. In Regs. Sec. 1.163-1(b), it states that an “equitable owner” may deduct interest expense, even though he is not directly liable for the mortgage. The Tax Court ruled that because Uslu exclusively occupied the residence, made all the mortgage payments directly to the lender, and paid all expenses for repairs, maintenance, property taxes, insurance, and improvements, he was deemed the “equitable owner”.
If you are considering alternative financing for which someone else will be legally responsible, we strongly recommend that you structure a written, enforceable agreement that clearly identifies you as the equitable owner and assigns you the benefits and burdens of home ownership. You should then make sure that both parties act consistently in upholding the agreement.