In 2002 Benjamin Puentes bought a house in South San Francisco. He made the required down payment and financed the balance of the purchase price with a mortgage loan secured by the property.
In 2003, Lourdes Puentes, Benjamin’s sister, started living in the house when she moved to San Francisco to attend college.
When Lourdes’s father became ill in 2005, he started living in the house, too
Benjamin made all required mortgage payments on the property until he became unemployed in 2009. At that point Lourdes began making mortgage payments. She had not contributed to the down payment, and she is not a party to, or otherwise obligated on, the mortgage loan. Benjamin is the sole legal owner of the property.
All three family members—Benjamin, Lourdes, and her father—resided in the house during 2010. Benjamin remained unemployed that year, and Lourdes and her father continued to defray many household expenses. Her father paid for repairs and supplies. Lourdes paid $3,317 in property taxes and $311 in homeowner’s insurance, which the property insurance company had billed to Benjamin. She paid these expenses even though she was not obligated to do so.
Lourdes also made monthly payments toward the mortgage loan during 2010 even though she had no legal obligation to do so. The mortgage lender listed Benjamin’s name, and only his name, on the Form 1098, Mortgage Interest Statement, which reported the payment of $33,097 of loan interest during 2010. Lourdes, rather than Benjamin, nevertheless claimed a mortgage interest deduction on her tax return on account of this interest.
The IRS issued Lourdes a notice of deficiency disallowing the mortgage interest deduction.
Ms. Puentes appealed the notice of deficiency at the appropriate levels, eventually filing a case in US Tax Court.
Who won in US Tax Court, the IRS or Ms. Puentes?
Ms. Puentes paid the mortgage and insurance payments on her brother’s home when he became unemployed and could no longer make the payments. Remember, Ms. Puentes also lived in the home and had done so for several years. She was simply trying to take care of her brother the way he had taken care of her several years earlier.
Even though the mortgage company issued the Form 1098 to Benjamin Puentes, the borrower and Ms. Puentes’s brother, Ms. Puentes deducted the mortgage interest on her tax return. The IRS disallowed the deduction, and Ms. Puentes appealed the decision to the US Tax Court.
So who did win — the IRS or Ms. Puentes?
The US Tax Court analyzed the situation this way.
A taxpayer is generally allowed a tax deduction for interest paid or accrued on “qualified residence interest,” which includes interest paid on “acquisition indebtedness with respect to any qualifying residence of the taxpayer. A taxpayer may deduct, as home mortgage interest, “[i]nterest 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 directly liable upon the bond or note secured by such mortgage.” Sec. 1.163-1(b), Income Tax Regulations.
The record established that Benjamin had been the sole legal owner of the property from the time he purchased it in 2002 through 2010. California law thus presumes him to be the full beneficial and equitable owner as well.
Ms. Puentes was not entitled to the tax deduction for mortgage interest
Unfortunately for Ms. Puentes, she offered no evidence that she had any agreement with Benjamin entitling her to an ownership interest in the property. She moved into the house in 2003, when she began attending college. Benjamin appears to have made all mortgage (and other) payments on the property for at least six years, until he became unemployed. There was no information presented to the Court to support the contention that Benjamin intended to give his sister an ownership interest in the house in 2002 or at any later time.
Second, the fact that Ms. Fuentes paid the mortgage, home insurance, and property taxes during 2010 was not sufficient to make her an equitable owner of the property. She benefited from her brother’s generosity when he made those payments during 2003-2008, and he benefited from her generosity when she made those payments during 2010. She made the payments not because she owned the property but because her brother was unemployed.
Finally, the court record did not have any evidence that Ms. Puentes held any ownership interest in the property. She did not contribute to the down-payment in 2002, and she did not make mortgage (or other) payments on the property between 2002 and the time her brother became unemployed. Although she resided in the house and paid certain expenses voluntarily, she was not legally obligated to bear any burdens of ownership.
The Court said that Ms. Puentes had acted admirably to enable her family to retain its home at a time of economic difficulty, and the court empathized with her position.
However, the Court decided that Ms. Puentes was not entitled to the tax deduction for mortgage interest.
What do we learn from this?
There may be legitimate ways to structure your financial arrangements if you find yourself facing a problem such as Benjamin and his sister were facing. But, you need to contact a competent financial professional at the beginning to determine what the appropriate solution is and to get the correct documentation in place. If you wait until it is time to file your tax return, you have waited too long.