Cohabitation Doesn’t Cut It with the IRS

Now that I have gained some attention from you millennials (and possibly parents of millennials), first take a deep breath.  We’re talking IRS tax deductions, not the social aspect of cohabitating.

Let’s set the stage here.  An unmarried couple lives together in a residence that is owned and financed solely by Partner A because Partner B could not qualify for a mortgage.  Partner B transfers $1,000 in cash every month to make interest-only mortgage payments on the residence.  Partner B takes a mortgage interest deduction on Schedule A of their tax return for the transfer to Partner A.

Not so fast, says the IRS.  In a Tax Court Summary Opinion, the IRS argued that Partner B did not show they had the benefits and burdens of ownership.  Partner B failed to substantiate the deduction.

Benefits and Burdens of Ownership

Under Code Sec. 163, a taxpayer is generally allowed a deduction (within dollar limits) for payments of qualified residence interest, which includes interest paid on acquisition debt with respect to any qualifying residence of the taxpayer. A taxpayer may deduct, as home mortgage interest, interest paid on a mortgage on real estate of which they are the legal or equitable owner, even though they are not directly liable on the bond or note secured by the mortgage.

In determining whether a taxpayer possesses any of the benefits and burdens of ownership of property, the Tax Court has considered whether the taxpayer:

. . . has a right to possess the property and to enjoy the use, rents, or profits thereof;

. . . has a duty to maintain the property;

. . . is responsible for insuring the property;

. . . bears the property’s risk of loss;

. . . is obligated to pay the property’s taxes, assessments, or charges;

. . . has the right to improve the property without the owner’s consent; and

. . . has the right to obtain legal title at any time by paying the balance of the purchase price.

The Verdict

However, here, the Court said that Partner B did not provide any objective evidence that they paid the mortgage interest in issue or that they were the equitable or beneficial owner of the property in question. Partner B did not produce any bank statements, receipts, or similar records to show that they transferred any amounts to Partner A to pay the mortgage or other expenses related to the residence. There was no showing that Partner B could make improvements to the property without Partner A’s consent or that they could obtain legal title to the property by paying the balance due on the mortgage. Partner B testified that Partner A paid all of the homeowner’s insurance premiums and property taxes on the residence.

Shared Ownership Agreement

So what should cohabitating couples do?  Consider a shared ownership arrangement.  One that could reasonably expect that both partners would commit the terms of their agreement regarding ownership of the residence to writing.  For example, a written statement of their respective rights to possess the property or to share in the benefits and burdens of ownership, such as mortgage payments, real estate tax payments, insurance premiums and repairs and maintenance.

If you are unsure of the tax aspects of cohabitation, and would like to rest assured that you qualify for your mortgage interest deduction, real estate tax deduction and other residential deductions, please contact an Anders advisor.