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ASK THE EDD ATTORNEY – CAN YOU DEDUCT MORTGAGE INTEREST PAID ON REAL PROPERTY NOT IN YOUR NAME?

By Robert S. Schriebman
November 15, 2016

Introduction

People who fear the taxman or creditors will sometimes purchase real property in someone else’s name but make the mortgage payments, pay property taxes, and make improvements. If the title to the realty is not in their name, will they be allowed to deduct the interest and the taxes paid?

If this question was put to the typical IRS or FTB tax auditor, you can expect that the deductions taken for mortgage interest and property taxes will be disallowed – thrown out. Is the auditor correct in disallowing the deductions solely because the title is not in the payer’s name? I can tell you from experience that the auditor’s determination will be supported by his or her supervisor as well as higher ups in both the IRS and the FTB. But are they correct?

The Case Of James David Jackson

James lived with Julie. They were not married; they were domestic partners. They lived in Nevada, a community property state. James had personal financial problems. In 2005 Julie financed the purchase of a residence with a mortgage provided by Countrywide Financial (now Bank of America). Each month James gave $1000 in cash to Julie to make an "interest only" payment on the residence. In 2005 and 2006 James deducted the interest paid on Schedule A of his individual 1040 return. The IRS disallowed the deductions and James took the IRS to the U.S. Tax Court. Jackson v. Commissioner, U.S. Tax Court, T.C. Summary Opinion 2016-33, (Jul.5, 2016).

U.S. Tax Court Special Trial Judge Guy, affirmed the IRS disallowance of the interest deductions, but Judge Guy went into an excellent explanation that the reason James did not prevail was solely because he could not prove the amount of money he paid on the mortgage because it was paid in cash with no records. Julie sent a letter to the Tax Court affirming James’ payments. However, Julie did not appear in Court and she did not testify; a fatal error. "A taxpayer must substantiate deductions claimed by keeping and producing adequate records that enable the Commissioner to determine the taxpayer’s correct tax liability." IRC §6001.

How To Do It Right

IRC §163 (h) (3) and (4) allows the deduction, interest paid or accrued on a qualified residence. Technically this is known as "Acquisition Indebtedness." Acquisition Indebtedness must be an obligation of the taxpayer and not an obligation of someone else. See Golder v. Commissioner, 604 F. 2d 34, 35 (9th Cir. 1979). However, IRS Regulation 1.163-1(b) provides that interest paid by the taxpayer on a mortgage of which he is the legal or equitable owner, even though the taxpayer is not directly liable, may be deducted as interest on his or her indebtedness.

If the taxpayer can establish that he or she is the real owner of mortgaged property he or she may be able to deduct the interest actually paid; but you have to have good records. In Uslu v. Commissioner, T.C. Memo 1997—551 the taxpayer was allowed to deduct interest paid on real property in the name of a third person because of a recent bankruptcy. In Uslu the taxpayer’s brother took out the mortgage and held the paper title, but the real owner paid the mortgage, property taxes, and made improvements. Under the law, the payer was the equitable owner and was entitled to the deductions.

State law determines the nature of property rights, but the Internal Revenue Code determines the tax consequences of those rights. The law of Nevada recognized that James and Julie were legally unmarried, co-habiting adults and as such they may expressly or impliedly agree to hold property as though it were community property. Hay v. Hay, 678 P.2d 672, 674 (Nev. 1984. We have the same rules in California See Marvin v. Marvin, 557 P.2d 106 (1976).

If the title is not in your name, but you pay the mortgage, taxes, and make improvements, the key to successful deductions will be the completeness of your record keeping.

Why Did James Lose?

James did not produce any bank statements, receipts, or similar records to show that he transferred any monies to Julie to pay the mortgage or other expenses related to the residence. Julie should have appeared in Court to testify. If you want the deductions, you cannot go it alone. You need not only good records but also the testimony of the person in whose name the title resides to testify that you are, in reality, the real owner and the other person is only a straw man.

Conclusion

We live in an electronic age. If you want to do banking all you need is your cell phone. You can pay most of your bills through your cell phone. While this may be convenient, it may prove to the lazy person’s way to ruin. I have found, over the years, that to win your case in court you must have clear and convincing evidence to the point where the IRS or FTB is painted in a corner where "checkmate" is lurking. In other words, it’s the old fashioned "paper-trail" that wins the day. James lost because he had no records other than a letter from Julie without her testimony to back it up. Cash may be king, in many transactions, but it is knave in the U.S. Tax Court.

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Robert Schriebman has a successful practice in the Rolling Hills Estates area of Los Angeles County serving clients throughout California and the United States. He has successfully dedicated more than 40 years to helping individual taxpayers, business owners, CPAs, Enrolled Agents, and tax attorneys navigate the complicated tax systems of the federal and state governments.

Robert Schriebman has written the only 2 books ever published dealing with how California Employment Development Department (EDD) operates. See "California Tax Collection Practice and Procedures" and "California Taxation Practice and Procedure," both published by Commerce Clearing House.

Robert Schriebman has written over 20 books including the major manual used nationally by practitioners and the IRS, "IRS Tax Collection Procedures – A Manual for Practitioners" published by Commerce Clearing House.

Robert Schriebman has written over 20 books including the major manual used nationally by practitioners and the IRS, "IRS Tax Collection Procedures – A Manual for Practitioners" published by Commerce Clearing House in addition to the only 2 books ever published dealing with how California Employment Development Department (EDD) operates. See "California Tax Collection Practice and Procedures" and "California Taxation Practice and Procedure," both published by Commerce Clearing House.

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