Q: Our son just graduated and got a decent-paying job. He wants to buy a condominium and we are prepared to lend him the entire purchase price. Is there anything we should be doing to secure our investment? This is not a gift to our son.
A: Yes, there is something you should do, not only to protect your investment but to give your son a little extra dividend. You should have him sign a promissory note and a deed of trust (in some states it’s called a mortgage).
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How does this safeguard your money? If your son cannot pay, you can always foreclose; on the other hand, if he sells the condo or decides to refinance with another lender, you will be paid off in full.
If the deed of trust is recorded among the land records where the condo is located, your son can deduct the mortgage interest. You will, however, have to pay income tax at ordinary rates on the interest you receive.
Under our tax laws, the only way that a borrower — in this case your son — can deduct the interest paid on the loan is to have the deed of trust recorded.
I would consult a real estate attorney in the state where the condo will be located. Your son will sign the promissory note. You can determine a favorable interest rate by looking at the IRS Applicable Federal Rate, which is published monthly. Have a lawyer draft the deed of trust so it complies with local law; after it is signed, it will be recorded.
One important thing to remember: When your son pays off the loan, make sure that a release, typically called a certificate of satisfaction, is recorded among those same land records. All too often, private loan transactions are not released and that causes title attorneys like me a lot of headaches.
Q: My mother owns a house and I have started to pay the monthly mortgage. A friend told me I can deduct the mortgage interest. Is that correct?
A: There is no easy answer. Unfortunately it depends on the facts. If you are not on title, in most cases you cannot claim any interest tax deductions.
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But there is one important exception: If you have an “equitable ownership interest” in the property, you may be able to claim the interest deduction. What does this mean? According to a recent tax court decision, you assume the benefits and the burdens of ownership.
There are a number of factors to take into consideration. The court listed the following:
1. Do you have the right to possess the property and enjoy its use, rents and profits?
2. Do you have an obligation to maintain the property?
3. Are you responsible for insuring the property?
4. Do you bear the risk should there be a loss?
5. Are you obligated to pay the real estate tax?
6. Can you make improvements to the property without the owner’s consent?
7. do you have the right to obtain legal title at any time by paying the balance of the purchase price?
You don’t have to meet all seven of these tests, but they give you an idea of what equitable interest is.
Why don’t you go on title with your mother? Or, if it is more advantageous for you to take all of the tax deductions, why not buy your mother out? Talk with a lawyer about the tax ramifications of ownership.
Benny Kass is a practicing attorney in Washington, D.C., and in Maryland. He does not provide specific legal or financial advice to any reader. Readers may email him, but he cannot guarantee a personal response.
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