Deducting Mortgage Interest Payments Made by a Third Person

The United States Tax Court ruled that paying a siblings mortgage may not be deductible by the party making the payment unless the payor can establish that the payor has assumed the benefits and burdens of ownership of the property (equitable interest).

In this case, brother and sister lived together. The brother was the legal owner of the house, but the sister made the mortgage payments after the brother became unemployed. The IRS does not allow a deduction of mortgage interest by the sister. The sister claimed she had an equitable interest in the property since she lived on the property.

The IRS does not allow a deduction for mortgage interest where the taxpayer does not establish “legal or equitable” ownership of the mortgaged property. 

1.  Sec. 163 allows a deduction for interest paid or accrued for a mortgage on real estate of which the taxpayer is legal or equitable owner, even though the taxpayer is not directly liable on the bond or note secured by such a mortgage. The U.S. Tax Court stated it disallows a deduction for mortgage interest where the taxpayer does not establish legal or equitable ownership of the property. Legal ownership means the taxpayer’s name is on the deed. Equitable ownership means the taxpayer has assumed the benefits and burdens of owning the property even though the taxpayer may not be on the deed to the property. 
2.  State law determines property rights and Federal law determines the appropriate tax treatment of those rights. 
3.  The property is located in California. Under California property law, the legal owner is presumed to be the owner of full beneficial interest and this presumption may be rebutted by clear and convincing evidence.

Under Federal tax law, certain factors are considered by courts to determine whether a taxpayer has assumed the benefits and burdens of ownership by considering whether a taxpayer had any rights to the property including, but not limited to the following: (1) to possess theproperty and to the use, rent and profits of the property; (2) duty to maintain the property; (3) responsible for insuring the property; (4) assumed the risk of the loss of the property; (5) obligated to pay taxes, assessments, and charges against the property; (6) has the right to improve the property; and, (7) to obtain legal title at any time by paying the balance of the purchase price.

In the case, the sister offered no evidence that she had an agreement with her brother entitling her to any of the above enumerated factors.