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.
