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amoreshead14
New Member

Half Investment, Half Primary Residence

My brother and I want to buy a house together. We each put 10% down. I live in the house and pay the mortgage. Our ownership % does not change, as essentially, I am paying his half of the mortgage as rent.

What are the tax implications of this for each of us and does he need to be on the title? We want to sell in a few years and have the gains offset with appropriate tax depreciation.

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Anonymous
Not applicable

Half Investment, Half Primary Residence

won't work. based on what was stated all use would be regarded as personal use. no depreciation would be allowed.  doesn't matter whether he's on the title or not.  paying his half of the mortgage is not rent. 

 

the problem is that any day rented to a family member is a personal-use day unless the rent is at fair market value and the family member occupies the house as their principal residence. 

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Hal_Al
Level 15

Half Investment, Half Primary Residence

It's complicated. As you describe it, your half is your principal residence. Your brother’s half is a 2nd home,  to him., not a rental unit.  He is not allowed any rental deductions, including depreciation.

 

When you sell, your capital  gain is tax free (up to $250,000), under the home sale rules.  His half of the gain is taxable to him, at long term capital gains rates.

 

In order for him to treat his half as a rental unit, you must pay him fair market rent.  Just covering expenses, like mortgage interest, is not enough.  

 

“We want to sell in a few years and have the gains offset with appropriate tax depreciation.” That’s not how a rental works.  If he charges you fair market rent. He has to report the rent as income, each year. But, he gets to deduct expenses, like mortgage interest, and depreciation.  This almost always results in a yearly tax loss that he can deduct against other income.  However, when he sells the unit, he has to “recapture” (pay tax on) depreciation claimed (or allowed to be claimed). Depreciation recapture is taxed as ordinary income, not at capital gains rates.

 

You would not be allowed to deduct the portion of the mortgage interest and real estate tax that is designated as rent (in a fair market rental rate situation).

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7 Replies
Carl
Level 15

Half Investment, Half Primary Residence

For starters, there's no such thing as "half investment". An investment is an investment. Period. Now there are different types of investments consisting of two extremely basic types. Those investments that make you money, and those investments that cost you money.

Buying a brand new $50,000 car is an investment. But more than likely that is an investment that will cost you money in the long run because you're not going to profit from it's sale in the future.

Buying a $100,000 house is also an investment. It can be a personal investment, or a business investment. There is a difference. If you buy a house with the intent of using it in a business (such as renting it out) then it's a business investment because your "INTENT" is to make a profit. Weather you actually make a profit or not is not relevant. It's your "intent" that is relevant.

If you buy a house to use as your primary residence, then it's a personal investment. While you may make a profit when you sell the property years down the road, that was not your "intent" when you purchased it. Your intent was to have a place to call home.

My brother and I want to buy a house together. We each put 10% down. I live in the house and pay the mortgage. Our ownership % does not change,

So far, so good, as that is absolutely true.

as essentially, I am paying his half of the mortgage as rent.

There's nothing "essentially" about this. Either you have a rental contract that you are legally obligated to pay the contracted amount to your brother, (for living in his 50% ownership) or you don't.

Overall, I highly suggest the two of you seek legal counsel not only from a real estate attorney, but also from a tax professional. Here's just a few things I'll point out here.

 In order to claim the mortgage interest and property taxes on your tax return, there are two criteria that must be met.

 1) You must be legally obligated to pay it. (You are if your name is on the loan and the deed)

2) you must have actually paid it, and be able to prove it if audited.

So if the one not living in the house is not paying at least their share of the property taxes and mortgage payments out of money they can prove is their money, they have no claim to those deductions on their tax return from a purely legal standpoint.

What are the tax implications of this for each of us and does he need to be on the title? We want to sell in a few years and have the gains offset with appropriate tax depreciation.

You two have a few options, and I recommend you seek legal advice from a tax attorney, as well as a real estate attorney before committing to anything.  This would be especially advised if your state also taxes personal income.

 - One brother can formally rent their 50% ownership to the one actually living there. To keep things right on paper and so that property documentation can be provided in case of audit, the resident brother should pay rent "directly" to the non-resident brother. For the property taxes and mortgage payments, each brother should write a check for their share from their individual checking accounts, payable directly to the mortgage holder, as well as property taxes directly to the taxing authority. Typically, property taxes are escrow-ed as a part of the monthly mortgage payment. So each brother writing a check to the lender each month for their share of the total payment (which includes escrow) will be just fine for "their half" of the property taxes.

The non-resident brother will have to report all of their rental income on SCH E as a part of their personal tax return. This will allow the non-resident brother a few more deductions, since they are using their half of ownership for 100% business use a a rental. This can seem complicated. But once understood, it's really not. It's getting to that "understanding" of how it works that can take a bit of time to explain.  One thing that affects stuff for the "landlord" is if they are renting at fair market value, and if they are renting to a family member.

 

- If the resident brother is the one making all the payments for everything, then the non-resident brother can just "gift" their portion of the down payment to the resident brother and be done with it. The IRS Form 709 - Gift Tax Return only needs to be filed is the amount gifted exceeds $15,000 in any one tax year. Do not let the name of that form mislead you. There will "NOT" be any tax paid by "ANYONE" on the gifted amount. A gift is not taxed. But if it exceeds $15,000 in any one tax year, it is required to be reported to the IRS on Form 709.

 

If the non-resident brother wants to do a quit claim on the property to give the resident brother full and complete ownership, they will need the permission of the mortgage holder to do that. More than likely the mortgage hold would not give that permission. But if they did, then that non-resident brother is still legally liable for the mortgage loan.

If you go and do a quit claim without the mortgage lender's permission, the local courthouse will honor the quit claim and process it. However, that could very well put both of you in violation of your loan terms making the entire balance on the loan due and payable immediately and/or subject to foreclosure. The lender will become aware of this since they are a listed lien holder on the property, when the courthouse sends them an updated deed after processing the quit claim application. So be aware of that if you elect to pursue this route.

 

Typically, when you sell real estate in the future a 1099-S will be issued to the primary borrower listed on the loan. Secondary borrowers get nothing. However, that doesn't prevent the borrowers from splitting the income on their tax returns if they had legal ownership of the property prior to the sale or other disposition. Just make sure the closing agent makes out two checks  - with each check payable to each owner. Otherwise, with a single check made out to only the primary owner, this will not only create additional paperwork at tax time, but it could be difficult to prove a split of the proceeds if audited. (I didn't say impossible, I said "difficult.)

 

-Another thing to consider, what if one of you dies in the next few years? Or becomes unable to work and produce income? Or there's a falling out and one of you just flat out refuses to pay your share?

Overall, seek professional help and advice from both a real state professional as well as a tax professional on this, to help you set things up correctly for any future possibilities not only for the property, but for yourselves as well.

 

Anonymous
Not applicable

Half Investment, Half Primary Residence

won't work. based on what was stated all use would be regarded as personal use. no depreciation would be allowed.  doesn't matter whether he's on the title or not.  paying his half of the mortgage is not rent. 

 

the problem is that any day rented to a family member is a personal-use day unless the rent is at fair market value and the family member occupies the house as their principal residence. 

View solution in original post

Hal_Al
Level 15

Half Investment, Half Primary Residence

It's complicated. As you describe it, your half is your principal residence. Your brother’s half is a 2nd home,  to him., not a rental unit.  He is not allowed any rental deductions, including depreciation.

 

When you sell, your capital  gain is tax free (up to $250,000), under the home sale rules.  His half of the gain is taxable to him, at long term capital gains rates.

 

In order for him to treat his half as a rental unit, you must pay him fair market rent.  Just covering expenses, like mortgage interest, is not enough.  

 

“We want to sell in a few years and have the gains offset with appropriate tax depreciation.” That’s not how a rental works.  If he charges you fair market rent. He has to report the rent as income, each year. But, he gets to deduct expenses, like mortgage interest, and depreciation.  This almost always results in a yearly tax loss that he can deduct against other income.  However, when he sells the unit, he has to “recapture” (pay tax on) depreciation claimed (or allowed to be claimed). Depreciation recapture is taxed as ordinary income, not at capital gains rates.

 

You would not be allowed to deduct the portion of the mortgage interest and real estate tax that is designated as rent (in a fair market rental rate situation).

View solution in original post

Carl
Level 15

Half Investment, Half Primary Residence

As you can see by all the different responses here, this is not simple by any stretch of the imagination. So the need for both of you to seek legal counsel should be blatantly obvious.

tagteam
Level 15

Half Investment, Half Primary Residence


@Carl wrote:

...Here's just a few things I'll point out here.

In order to claim the mortgage interest and property taxes on your tax return, there are two criteria that must be met.

 1) You must be legally obligated to pay it. (You are if your name is on the loan and the deed)


I just wanted to point out that a taxpayer's name does not have to be on the loan nor does a taxpayer have to be liable for repayment in order to claim the mortgage interest deduction.

 

Treas. Reg. §1.163-1(b): Interest 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, may be deducted as interest on his indebtedness.
Carl
Level 15

Half Investment, Half Primary Residence

This can be (or can get) rather complicated. Hence, the recommendation for legal advice. What you're talking about here is the "vested interest" thing. If legal advice is sought (and it would be foolish not to) I"m confident any competent advisor would educate them on this. But weather vested or not, the requirement to have actually paid it, still stands true.

 

tagteam
Level 15

Half Investment, Half Primary Residence


@Carl wrote:

This can be (or can get) rather complicated. Hence, the recommendation for legal advice. What you're talking about here is the "vested interest" thing. 


Again, the point here is not at all complicated; a legal or equitable owner of real estate can deduct mortgage interest even if the owner has no personal liability on the loan.

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