Making mortgage payments on a residence doesn't automatically entitle you to related tax deductions.
Since this is probably becoming an increasingly common situation, as more couples opt to remain unmarried, here is the full story on this case and the lesson for taxpayers.
In 2003, the taxpayer began living with her boyfriend in a Massachusetts home he had purchased in 2002. Initially the taxpayer paid rent to the boyfriend. In 2004, he quit his job and went back to school, and the taxpayer began paying more of the couple's living expenses. In late 2006, they had a child together, and the boyfriend decided to become a stay-at-home dad. In 2007, the taxpayer decided she should have an ownership stake in the home, since she had been paying most of the bills for some time and apparently would continue to do so. In June of 2007, her name was added to the property deed and the mortgage document, and she began making the monthly mortgage payments directly to the lender. (Before then, the taxpayer's contributions towards the house payments had been given to the boyfriend, and he had paid the lender.)
On her 2007 Form 1040, the taxpayer deducted $16,358 of mortgage interest, which was apparently 100% of the interest paid during that year. However the lender sent a Form 1098 (Mortgage Interest Statement) to the Internal Revenue Service showing that she had only paid $5,974, which was apparently the amount of interest paid after her name was added to the mortgage. Based on this discrepancy, the IRS audited the taxpayer and disallowed all but $5,974 of her mortgage interest deduction. Seeking relief, she went to the Tax Court.
The Tax Court's Decision
The court noted that home mortgage interest can generally be deducted only by a person who is legally obligated to pay the mortgage (in other words a person who is named as an obligor on the mortgage document). However, there is an exception to the preceding general rule for interest paid on a real estate mortgage when a person is a legal or equitable owner of the real estate but is not directly liable for the debt.
The determination of whether or not a person has legal or equitable ownership is a matter of state law. The taxpayer claimed that she had established equitable ownership by the beginning of 2007 by paying for a portion of the house payments over the preceding years and by paying for some improvements to the home. She also claimed that she and her boyfriend reached an oral agreement in early 2007 that she was entitled to share in any profit from selling the home, which led to her name being added to the property deed and mortgage document in June of 2007. However, the Tax Court decided she had no equitable ownership under Massachusetts law until her name was placed on the property deed and the mortgage document in June of 2007.
Apparently still searching for a way to give the taxpayer a break, the Tax Court then looked beyond Massachusetts state law for additional factors that could potentially give her an equitable ownership stake. According to the court, these factors included:
- whether she had a right to possess the property and enjoy the use, rents or profits thereof
- whether she had a duty to maintain the property
- whether she was responsible for insuring the property
- whether she bore the risk of loss if the property was damaged or destroyed
- whether she was obligated to pay taxes on the property
- whether she had the right to improve the property without the official owner's (boyfriend's) consent
The Lesson for Taxpayers
Just because you pay the bills does not mean you are automatically entitled to the related tax deductions (although it can't hurt). In this case, the taxpayer did not take the necessary steps to establish that she was a co-owner of her residence until June of 2007. As a result, she lost valuable deductions for mortgage interest that she apparently paid. This case provides yet another illustration of why you should keep your tax professional informed about what you are up to all year. If you wait until return filing time, it might be way too late to get the best tax results for yourself