CPA Says No Interest Deduction
I bought a house using the "Subject To"
technique. For almost one year, I have been making the mortgage payments on the property. A couple of days ago, I got the 1099 interest statements from the ****Must Reach Freshman Investor status before posting URL's***he loan is still in the name of the guy who's on the mortgage.
I had lunch with my CPA yesterday. I asked her about taking the interest deduction. She says that I can't take the deduction because the mortgage is not in my name and can only be deducted by the one who is liable for the mortgage -which would be the previous owner.
Question: Is this correct?? I've made the payments like clockwork each month and I can't deduct the interest???
But, if the owner (who didn't make a payment) wanted to he could take the deduction??? I don't really care about the previous owner.
Can I or can't I take the tax deduction. If you could direct me to the code, I'd be appreciative. 
You can certainly deduct your interest. It is a legitimate business expense. I don't know enough on the subject to give you more advise but maybe DaveT can help. He seems to have an overall better knowlege of tax law than I do.
Is the property in a land trust? Do you have the deed? If so, I'd say find a new CPA, but I'm interested to see what Dave T tells ya.
Thanks,
OnTheWater
richgarcia,
Glad to meet you.
My question would be is the Deed to the property in your name?
John $Cash$ Locke
never having done a subject -to, but understanding a little about them, I don't know how you could possibly take the interest deduction. It is not your mortgage, why would you get credit? One of the reason you bought subject-to was that you didn't want want to get a mortgage, remember?
The Deed has been in my name since the beginning of the transaction. The mortgage remains in the name of the previous owner. Sorry I didn't put this information in the original post.
jksal,
Every buyer that purchased one of my properties can claim the interest deduction legally, so your theory is incorrect.
If you are posting to help someone then your thoughts are much appreaciated, if you are guessing then you do yourself a dis-service as well as the posters here looking for correct information.
I am trying to find out whether this person purchased Subject To from the original seller, was sold the property by an investor, what method of investing are they using to purchase the property.
I am even pretty sure DaveT would need to have this information to make a reasonable assesment.
John $Cash$ Locke
richgarcia,
Since you told me this, my advice would be to change CPA's.
Your are intitled to take the interest deduction if you are the one making the mortgage payments and the deed is in your name.
John $Cash$ Locke
John,
If he doesn't own the Mortgage, yes he owns the house, I don't know how he can leagally claim teh interest deduction as teh previous owner is still on the hook for the mortgage.
jksal,
Then tell me who gets the interest deduction?
The one who is paying the mortgage payments regardless whose name is on the mortgage or the person's whose name is on the mortgage.
John $Cash$ Locke
I had the same situation for three years. I consulted my CPA and was told that I could absolutely take the deduction as long as the seller didn't try to take it. I never had an issue and have since refinanced.
JohnBergman,
Glad to meet you.
We are getting close here, if the owner tried to take the interest deduction and did not himself pay the mortage payments, I think Uncle would have a big problem.
You would have been fine because you had cancelled checks as proof you paid the mortgage payments.
John $Cash$ Locke
PS: DaveT give us the statutes here.
Quote:I had lunch with my CPA yesterday. I asked her about taking the interest deduction. She says that I can't take the deduction because the mortgage is not in my name and can only be deducted by the one who is liable for the mortgage -which would be the previous owner. richgarcia,
You can deduct home mortgage interest only if you meet all the following conditions. You must file Form 1040 and itemize deductions on Schedule A (Form 1040).
You must be legally liable for the loan. You cannot deduct payments you make for someone else if you are not legally liable to make them. Both you and the lender must intend that the loan be repaid. In addition, there must be a true debtor-creditor relationship between you and the lender.
The mortgage must be a secured debt on a qualified home. A wraparound mortgage is not a secured debt unless it is recorded or otherwise perfected under state law. Let's concede a point to your CPA and grant that the home mortgage interest deduction is only taken by the one liable for the mortgage -- the original Subject To seller.
In your situation, the mortgage interest paid is not treated as home mortgage interest. Instead, treat the mortgage interest paid as deductible business interest (non-farm) and report it on Schedule C (Form 1040), or on the appropriate forms for your business entity. See IRS Publication 535, Business Expenses for more information.
Coordinate with your accountant on your best method for handling this issue for your business entity. [ Edited by DaveT on Date 01/23/2004 ]
Followup to my previous post.
Richgarcia never tells us whether the property he acquired in a Subject To transaction is being used as his primary residence, or whether he is following John Locke's course and using a Contract For Deed exit strategy.
I (perhaps like most here) assumed that he was purchasing and selling the property as John teaches in his course. If this is the case, then my original response stands.
On the other hand, what if richgarcia is using the property as his primary residence? His CPA's response may be right on target with no further recourse. Because richgarcia is not legally liable for the loan secured by the property he owns and occupies as his primary residence, he cannot legally deduct the interest he pays as home mortgage interest on his Schedule A (1040).
In this case, the interest he pays is treated the same as interest on unsecured debt (for example, credit card interest) and is what the IRS would call a personal expense. Unfortunately for richgarcia, if he is in this situation, personal expenses are not deductible.
Great thread guys. I really learned alot. Thanks
This IS very interesting!
So, DaveT, how can our buyers deduct the interest?
I buy Subject to the mortgage staying alive, in the name of my seller; next I sell to a no qual buyer, who for 2 years pays the mortgage, and after that period of time, refinances.
Could it be that because the buyer makes his payments to a Loan Servicing Company, which in turn will send the buyer a statement with all the interest paid on that mortgage (which is not in his name), he now can deduct the interest on his tax form?
BTW, I have been making payments on a mortgage that is not in my name, directly to the lender, I do not live in that house, it is an investment property.
Can I deduct the interest paid from my taxes?
Ladybug
P.S.: I will have a meeting with my CPA in a couple of weeks, but I would like to be prepared in advance.
If you follow John Locke's selling strategy, you are selling on a contract for deed and recording a note. You and your buyer have a debtor-creditor relationship with a recorded (wraparound) note.
No problem for your buyer. The mortgage interest the buyer pays to you qualifies as deductible home mortgage interest.
For your investment property, the mortgage interest you are paying on the note you took Subject To is deducted as a business interest expense on your Schedule C, or on the appropriate form for your business entity.
Since you did not specify how you are using your investment property, should I assume that you are holding it as an investment rental. If this is the case, you are in a grey area.
The tax rules for Schedule E allow an expense for deductible mortgage interest. I would argue that the property is being used for a legitimate business purpose and the mortgage interest in your situation is otherwise deductible as a legitimate business interest expense.
As always, the information presented in this forum is for educational purposes only and should not be taken as legal or tax advice. Consult a licensed tax professional in your area for specific details.
Although I am not a CPA or a tax lawyer, the first test might simplify the issue. "Is there an agreement/contract for a commercial intent". If so, then in some way the costs associated with this investment "Should" be deductible as a business expense.
xvjim,
Since there is no question about the deductibility of mortgage interest as a business interest expense on Schedule C, I assume you are referring specifically to the Schedule E treatment.
The problem here is that the mortgage interest paid on a note in a Subject To transaction is not deductible mortgage interest if the property is your primary residence. It is deductible as business interest when you are engaged in an active business and those who follow John Locke's strategy completely are engaged in an active business.
If you add the property acquired in a Subject To transaction to your rental holdings and operate the property as a rental, you are not engaged in an active business. Instead you are engaged in a passive income activity. It is on this point -- this is the grey area -- where I can see arguments both for and against the deductibility of the mortgage interest. Such as,If the interest is not allowed as a deduction on Schedule A, then it should not be allowed as an expense on Schedule E, and, the counterpoint,
If the mortgage interest is a deductible business expense, then it should still be deductible when the property is in service for the production of income.
In my opinion, when your rental property is acquired in a Subject To transaction, you are playing tax audit roulette by claiming a mortgage interest expense on Schedule E -- you could win or you could lose. If you have at least a 33% chance of sustaining your position in an audit, I say take the chance. I would.
Here's how this works-
You are paying the previous owner(the one who is still liable on the mortgage) he has to take that as ordinary income and deducts the mortgage interest he then pays on the mortgage he is liable for. You, owning subject to, are not on the hook for the mortgage so you can't take the deduction. The CPA is right, period.
However, depending on your business, you can deduct your interest payments as a cost of doing business under Section 162 ordinary and necessary business expense.
JasonD,
Isn't this what I already said, or are you telling us something different?
The point I was trying to make was twofold- 1. You can't take the mortgage interest deduction if your not liable for the mortgage and 2. If you take it as a business deduction, it is irrelevant whether the interest is related to a mortgage or not. But generally, I agree with you have said, with subtle differences perhaps depending on whether he is a SP or partner in partnership or llc.
Is there a true "black and White" .... OR... is there some interpratation in there?
So ...... are you guys saying that the 3 parties, the buyer, you as an investor and the seller can deduct the interest???
Dave in this post you say that the buyer can deduct the interest they pay on the mortgage payments.
However it is also said in the thread that you as an invester can deduct the interest as a business expense and the origianl owner ( the seller) can deduct the interest because the loan is still in their name?????
I am confused, so everyone deducts the interests?????
quote]
On 2004-01-24 06:55, DaveT wrote:
If you follow John Locke's selling strategy, you are selling on a contract for deed and recording a note. You and your buyer have a debtor-creditor relationship with a recorded (wraparound) note.
No problem for your buyer. The mortgage interest the buyer pays to you qualifies as deductible home mortgage interest.
For your investment property, the mortgage interest you are paying on the note you took Subject To is deducted as a business interest expense on your Schedule C, or on the appropriate form for your business entity.
Since you did not specify how you are using your investment property, should I assume that you are holding it as an investment rental. If this is the case, you are in a grey area.
The tax rules for Schedule E allow an expense for deductible mortgage interest. I would argue that the property is being used for a legitimate business purpose and the mortgage interest in your situation is otherwise deductible as a legitimate business interest expense.
As always, the information presented in this forum is for educational purposes only and should not be taken as legal or tax advice. Consult a licensed tax professional in your area for specific details.
[/quote]
You are reading too much into my post.
I said that only the person legally liable for the loan CAN take a home mortgage interest deduction. I did not say that the seller in a Subject To transaction actually does take a home mortgage interest deduction, just that the investor/buyer is not entitled to the deduction as home mortgage interest because he is not liable for the loan.
The investor, instead, takes a business interest expense on his Schedule C for the amount of the interest paid on behalf of the original buyer.
When the investor sells the property on a Contract for Deed, he creates a wraparound mortgage note between himself and his buyer. When the note is recorded, the investor and his buyer have perfected a note for which the buyer is legally entitled to a [b]home mortgage interest[/] deduction for the amount of interest paid to the investor.
The investor reports the interest received as income on his Schedule C, and reports the amount of interest he pays on behalf of the original seller as a business interest expense on his Schedule C. The net difference is ordinary income to the investor.
DAve,
I understand your explanation, as to why I would write off the interest as a business expense as an investor and why the buyer would write it off as mortgage interests too, but then I don't understand the following statement from Jason ...........
[quote]
On 2004-01-27 16:50, JasonD wrote:
Here's how this works-
You are paying the previous owner(the one who is still liable on the mortgage) he has to take that as ordinary income and deducts the mortgage interest he then pays on the mortgage he is liable for.
When the original seller elects to take the home mortgage interest deduction, it is offset by the interest income received from the investor -- It's a wash for the original seller, isn't it?
I don't know for sure, but I suspect the Loan Servicing Company the investor uses will sort it all out correctly.
Dave,
makes sense, thanks so much for educating me. I just want to be prepared, in case either the seller or the buyer ask me those questions, also I think in the case of the buyer, it's another way to sell them on signing the CFD, if they know their name might not be on the deed right away but they would still get the same benefits of owning a home , tax wise.
Allow me to ask again about a person who is living in a property they purchase subject to a mortgage still in the name of the seller. It has been said the new owner cannot deduct the interest because they are not liable for the loan since it is not in their name.
LIABLE QUESTION?
On another website I read a different take on this "liable" was defined as suffering adverse consequences for not paying. And states that the owner can deduct the interest.
My Black's law dictionary seems to confirm this under the definition of liable, "bound or obligated in law or equity; responsible; chargeable; answerable; compellable to make satisfaction, compensation, or restitution.... Exposed or subject to a given contingency, risk, or casualty, which is more or less probable.
If the owner stops paying the mortgage payments that are in the sellor's name, isn't the owner subject to the risk of foreclosure. Isn't the owner compellable to make satisfaction (def. of satisfaction is to pay a debt) due to the lien and threat of foreclosure?
CREDITOR/DEBTOR RELATIONSHIP?
In the Black's law dictionary the U.C.C. definition of Creditor is a general creditor, secured creditor, a lien creditor, and any representative of creditors, etc. The bank has a lien on the property and a secured interest in the property owned, right? Black's law says the defination of debtor is "one who may be compelled to pay a claim or demand; anyone liable on a claim, whether due or to become due. Again, the owner is compelled to pay or risk foreclosure and loss of the home. So there is a legal and real creditor/debtor relationship.
Do we all understand the difference between equitable and common law? Note above that the definition of liable was both in law and equity. Law refers to common law which in laymens terms means "black and white letter of the law". Whereas equity means "according to fairness in a particular situation and denotes the spirit and habit of fairness, justness, and right dealing which would regulate the intercourse of men with men". You must admit that the owner is liable in equity for the loan if he can lose his HOME for not paying! right? Any judge would agree, I'm sure.
The owner is certainly the debtor and liable for the loan in equity if not in law.
So there is a legitimate creditor/debtor relationship between the bank mortgage (in preview owner's name) and the new owner because if he/she stops paying the bank can foreclose on the property.
So purchasing subject to satsifies the IRS requirements for deductions of interest, doesn't it?
Rather than ask a CPA, why not ask a Tax Lawyer experience in subject to and contract for deed IRS court cases. Because although I read up on the law, I have never litigated a case like this nor am I aware with any case history. Later I may take the time to seach some court rulings in the law library. That's the only way to be sure when everyone is singing a different song. I've taught a thing or 2 to lawyers AND CPA's by citing case history they weren't aware of or up to date on!!!!
Respectfully,
Mark Walter
GreaterReturn, LLC
DaveT,
You sad: "If you add the property acquired in a Subject To transaction to your rental holdings and operate the property as a rental, you are not engaged in an active business."
What legally defines the fact that you added-up a property to your rental holdings and you are not keeping it as part of your active business?
Mark,
For the Subject To buyer who occupies the property as his primary residence, let's start with the IRS rules for deducting mortgage interest paid on Shcedule A (1040) as home mortgage interest.
According to the IRS, you can deduct home mortgage interest only if you meet all the following conditions. You must file Form 1040 and itemize deductions on Schedule A (Form 1040).
You must be legally liable for the loan. You cannot deduct payments you make for someone else if you are not legally liable to make them. Both you and the lender must intend that the loan be repaid. In addition, there must be a true debtor-creditor relationship between you and the lender.
You assert that Quote:If the owner stops paying the mortgage payments that are in the sellor's name, isn't the owner subject to the risk of foreclosure. Isn't the owner compellable to make satisfaction (def. of satisfaction is to pay a debt) due to the lien and threat of foreclosure?
Black's law says the defination of debtor is "one who may be compelled to pay a claim or demand; anyone liable on a claim, whether due or to become due.I say no. If the new owner stops making the mortgage payments that are in the seller's name, it is the Subject To seller the bank will hold in default. It is the Subject To seller who will be notified that his loan is being accelerated. It is the Subject To seller who will be served notice of foreclosure. It is the Subject To seller who will be held liable by the lender for the note and who will suffer adverse circumstances with a destroyed credit rating.
Quote:The owner is certainly the debtor and liable for the loan in equity if not in law.
So there is a legitimate creditor/debtor relationship between the bank mortgage (in preview owner's name) and the new owner because if he/she stops paying the bank can foreclose on the property.If the new owner is not liable for the loan in law, then the new owner does not meet the IRS requirement of being "legally liable".
The lender and the Subject To seller still have a debtor-creditor relationship because it is the Subject To lender who will be sued for foreclosure. The subject To buyer who stops making the mortgage loan payments and allows the property to go to foreclosure can be sued in civil court by the Subject To seller for breach of contract and the Subject To seller can seek to recover damages from the Subject To buyer.
I still maintain that there is no direct debtor-creditor relationship between the lender and the Subject To buyer, and that the Subject To buyer is not legally liable to the lender for making the loan payments. Therefore, purchasing Subject To does not satsify the IRS requirements for deduction of home mortgage interest.
Quote:Rather than ask a CPA, why not ask a Tax Lawyer experience in subject to and contract for deed IRS court cases. I agree, with the warning that the Subject To transaction and the Contract For Deed transaction are two different transactions -- apples and oranges. We all agree that the Subject To buyer who sells the property with an installment sale is able to take a business interest deduction (Schedule C) for the mortgage interest paid on the note taken Subject To. So, when you are talking to your tax attorney about taking the home mortgage interest deduction on Schedule A (1040), just restrict your discussion to the Subject To buyer who wants to occupy the property as his personal residence.
Quote: "If you add the property acquired in a Subject To transaction to your rental holdings and operate the property as a rental, you are not engaged in an active business."
What legally defines the fact that you added-up a property to your rental holdings and you are not keeping it as part of your active business?omega1,
The IRS defines rental property operation as a passive income activity, by default, regardless of your level of active participation.
Legal enough for me.
Not my expertice, but as I understand it, your buyer can take the full deduction of the interest payment (for both loans if it's a wrap) if 1) They have a lease of LESS than 3 years AND 2) It is a NNN lease. See IRC # 163(h)(4)(d)
You can always renew at the end of 3 years if you both like, and the NNN makes it so that you never hear from them of course.
Let me know if this info matches up with what all of you understand.
I know that I am a little late with a response, but I had to add something to this conversation.
If you are going to claim the mortgage interest as a business deduction, as per DaveT, why not claim the entire mortgage payment. After all, if the house is being treated as a business, then every bill that you have pertaining to that house is a deduction. A FULL deduction. NOT just the interest, but the entire mortgage payment.
Also, if you are claiming the deduction, then you must also claim the entire amount that you receive each month from the optioner as rental income.
The difference that remains between the mortgage payment and the rental income is taxable income to the business entity you are using (minus any other repairs etc that you can use as a deduction).
Check with your new CPA, I'm sure he'll agree.
hibby76,
Everyone agrees that the mortgage interest is a business expense if you are engaged in the business of buying (Subject To) and selling (on Contract for Deed) as per John Locke's course.
The debate is confined to the individual who acquires the property Subject To and occupies it as his primary residence.
For this debate, we are also limiting our scope to the home mortgage interest deduction which is only available to the taxpayer on Schedule A (1040). In my reading of the rules that make an owner-occupant taxpayer eligible for this deduction, the Subject To purchaser does not qualify.
-------------------------------------------------
Worf,
The principle component of the mortgage payment is never a deduction, even for a business. It is a repayment of borrowed money for which no tax benefit accrues to either the lender or the borrower.
Doesn't the Subj To buyer (debtor) have a legal obligation to the Subj To seller (creditor) thereby making him eligible for the home mortgage interest deduction, even though the payments are not going directly to the seller.
It would seem to me that as long as a written agreement was in place with the seller that he would not take the deduction (which legally he still could as he also has a liability to the bank), and you provided evidence of those payments with your tax return, you would be in the clear. Hope that made sense.
In my humble opinion when buying Subject to as a primary residence, you would be allowed to take the mortgage interest deduction based upont the language in the subject to agreement that makes you morally, if not legally responsible for the payment. Gray area... Definitely. But, I believe you could provide adequate evidence that you are paying the mortgage on behalf of the seller. Thus, the seller would deduct the interest on the mortgage itself, as well as claim the interest that you paid on the sellers behalf, netting them 0. On the other hand, both the seller and the buyer (owner in the subj. to scenario) CANNOT both deduct the interest, for that would deprive Uncle Sam of his needed revenue. There needs to be a properly documented paper trail. In the investment strategies, I believe that as Dave T. has said, the interest, not the entire mortgage payment, would be deductible as business interest paid. I have a credit line on my cars in inventory and pay interest payments on the borrowed amount. The interest paid in a years time is tax deductible. Same would be true on a house or houses. I would ask my CPA, not if it is deductible, but where is it deductible. There are some semantics here, and your CPA probably doesn't know what's going on in your business.
[addsig]
I see that this important (for the owner of a subject to property used as their PRIMARY residence) question has surfaced again..
1) The members should refer to a post in the Tax/Tax Strategies Forum dated
2/6/04 entitled, "Sub2 Interest IS Deductilbe.
2) There is a landmark tax court decision which should put this question to rest once and for all (OR at least for today). This is a United States Tax Court -Memorandum Decisions. (Belden v Commissioner)
T.C. Memo.1995-360
Look it up.
I quote from the findings of fact and opinion
"Interest paid by the taxpayer on a mortgage upon real estate of which he is the legal or equitable owner, even though the taxpayer is not direcly liable upon the bond or note secured by such mortgage, may be deducted as interest on his indebtedness"
3) As I state in the above referenced 2/6/04 post . This is a " qualified residence" and the mortgage interest is deductible.