When can I deduct interest in Scottsdale or Paradise Valley?

IRS loses on disallowing interest deduction! When can I deduct interest and when can’t I?

IRS loses on disallowing interest deduction! By Jeffrey Brooks, CPA, CFP, MBA for JBrooks Wealth Advisors, PC, a CPA and CFP Professional Firm. jeff@jbrookswa.com or 602-687-9900 x101

I just completed another tax webinar. This tax webinar was 4 hours. I will be taking topics from this tax webinar over the next few weeks. I will share with you only the topics that might be useful to you.

This an actual recent court case. Wheeler TC Summary Opinion 2011-83.

Conrad Wheeler could not get a loan for the purchase of his house so his parents obtained the loan on his behalf. Conrad moved into his new house and although his parents were on the loan, Conrad made all the payments.

What triggered the IRS audit? Conrad deducted $87,003 of mortgage interest deduction. Conrad must have been paying a high interest rate. The IRS figured that if the average interest rate was 6%, then Conrad was taking a deduction on a loan over the $1.1 million ceiling. That is a NO NO and the IRS computers “spit” out tax notices.

1. Conrad understood that he would one day be
given legal title.
2. Conrad moved into the home on 1/10/2007.
3. On 12-3-07, Conrad’s parents deeded a small percentage to Conrad.
4. The court decided that Conrad can take deductions if he is an equitable owner.

Great news!! IRS has won on this issue in the past but this time the IRS lost!

The court decided in favor of Conrad because he had 1. The right to use and the property and was actually living in the property. 2. The only reason the parents signed on the loan was because Conrad could not qualify.
3. Conrad took care of insuring the property. 4. Conrad had the right to rent the property. 5. Conrad was responsible for risk of loss. 6. Conrad bore the risk of loss. 7. He was obligated to pay the property’s taxes, assessments, or charges and 8. He had the right to improve the property without his parent’s consent. In fact, he had improved the property and paid for these improvements. 9. He had the right to obtain legal title at anytime by paying the balance of the purchase price.

What is interesting is that the state where the taxpayer lived MUST allow Equity Ownership meaning that the only way Conrad would have been able to deduct the interest was if he lived in a state that allowed Equity Ownership rules (unlike Massachusetts that does not recognize Equitable Ownership) .

Due to the Tax Reform Act of 1986, interest is no longer always deductible.

For example, if Conrad’s parents had borrowed additional dollars before the housing crash and given the money to Conrad to start a new business, two events would occur. Either

1. Conrad’s parents would have to file a gift tax return because the total gift would have exceeded $26,000 ($13,000 from each parent) and if Conrad’s parents paid the interest and principal, they would have to report these amounts as a gift.
2. If Conrad owed his parents the funds (it was not a gift from the parents), Conrad could not deduct the interest unless he had enough investment income/business income to exceed the interest on the loan. Form 4952 would have to be prepared.
3. Conrad’s parents should instead loan the funds directly to Conrad’s business and Conrad could then deduct the interest on his business tax returns.
Please let me know if you have any questions.

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About Jeffrey Brooks

Jeffrey Brooks, CPA, CFP, MBA since 1976 has specialized in helping clients save significant taxes, help businesses increase their cash flow, revenues and profits while increasing their control and satisfaction. Jeff and his accounting firm sincerely cares about the happiness of his clients.

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JBrooks Wealth Advisors, PC.

Certified Public Accountant
Address: 4647 N 32nd Street, Suite B245
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Phone: 602-292-2009
Email: jeff@jbrookswa.com