Sub2 Interest IS Deductible
A post down the way states that a CPA says no interest deduction on Sub2 because the 1098 is in the old owners' name. That CPA is flat out wrong.
Reviewing Section 163 of the Internal Revenue Code and the associated case law, there is no question that the person who gets the deduction can include those who effectively assume a loan - and nothing says that the assumption has to be formal. In the case of a Sub2, you own the property, have a written contract that says you wil make the payments and in fact are making the payments. As such the interest is clearly deductible. In my view that is a "no brainer".
John Hyre, Attorney, Accountant, Investor
John,
I talked to my CPA recently and the topic of deductions came up. The fact that you are taking the house subject to with the intent to resell it...ie Contract for Deed, all monies paid on the house is deductible. She explained to me as these houses that I have are inventory, and any money spent on that house is an expense. Principal, interest, taxes, whatever. So I'm figuring up until the day I sell the house, all the money spent is an expense and after my buyers signs on the dotted line, I get no more deductions. Is this correct? AND, if that is the case, who cares how much was paid in interest, whatever the amount of the check I write is getting deducted. Do you agree?
[ Edited by nebulousd on Date 02/06/2004 ]
Greeting John.
Quick question...
Do you feel it's necessary in the contract that you also add something stating you will also be taking any applicable deduction? (just so they don't)
Thanks
Nebulousd: She's not quite correct. If the so-called Unicap rules apply, pretty much EVERYTHING gets CAPITALIZED to the property (that is, added to its basis, as opposed to written off. Basis gets written off later, when you sell the property), as opposed to deducted currently. Even in that case, however, principal does NOT get deducted or capitalized, otherwise you'd be double counting purchase basis in the home and getting a too-large cost of goods sold upon sale. The interest and all other expenses would be capitalized to the home. If the Unicap rules do NOT apply, then most expenses would get capitalized (e.g. - rehab), but we'd have a good argument for deducting interest, utilities and the like currently (as opposed to capitalizing and deducting when the property is sold). All of the above applies to inventory/flips, as opposed to sub2's treated as rentals. The rules for rentals are quite different and we know that interest is deductible (as opposed to capitalized) on rentals.
John Hyre, Attorney, Accountant, Investor[ Edited by JHyre on Date 02/06/2004 ]
Mcole,
I'd put that provision in less for IRS purposes and more for disclosure purposes. In an audit, YOU are clearly entitled to the deduction for any interest that you've paid and they are not - they'd simply lose if they were audited. More importantly, you want them to know it so they cannot accuse you of deceptive business practices or the like. Straight-up, honest and blunt disclosures are very important with Sub2, both for ethical and legal purposes.
John Hyre, Attorney, Accountant, Investor
Thanks John!
Very astute insight. I appreciate the input.
Just so everyone is on the same page, the post John refers to concerned the ability to deduct the mortgage interest by an owner-occupant who had acquired the property " Subject to". The individual had the deed to the property, used the property as his primary residence, and had been making the mortgage payments directly to the lender. I felt that the CPA was mistaken when she said, "No deduction for mtg interest".
I have bought most of my personal residences subject2 and deducted the interest expense. Through the years, I have wholesaled homes that I bought subject2 and the assignees have deducted the interest. I have taken subject2 ,put the property into a land trust and given the resident beneficiary the right to take the interest deduction. I feel that the interest can be deducted on transactions which meet the definition of a- Qualified Residential Property.
Let me specifically address the personal residence situation=. Qualified Residence:
1. The conveyance by deed immediately establishes legal/equitable ownership.
2. The owner has all the benefits and burdens of home ownership.
3. The owner can document that he is the payor of the mortgage.
4. This is the owner’s primary and personal residence.
5. The owner has a contractual obligation to pay the debt.
The above ingredients define a Qualified Residence.
The IRC talks about “acquisition indebtedness”. My Purchase Contract recognizes the debt by lender, amount, and loan number. While I state that I’m taking the property subject2 the mortgage(s), I contractually (legally) state that as further consideration, I hereby agree to pay the monthly mortgage payments promptly WITHOUT RELIEF. Lastly, I contractually agree to payoff the existing loan and obtain new financing within a stated number of www.months.Of course, I also state that I as the payor of the debt, get the interest deduction.
I believe that this indicates that I’m incurring the debt in acquiring the qualified residence. The debt is secured by the residence. I have a legal, contractual obligation for the debt, its repayment, www.etc.etc..
There are those who think that in
order to take the deduction a taxpayer needs to be directly liable on the note which secures the mortgage. That is not correct. I think that the conditions I have describe above amply satisfy the requirements to take the interest deduction.
Thank you John!!!
To clarify: I think that the owner occupant OR an investor get the deduction as long as they own the house and pay the interest. Either way, the former owner in whose name the property was does NOT get the deduction, even if the 1098 is still in their name.
John Hyre