Claiming Your $250,000 Exclusion When Your Name Is Not on the Deed
In last April’s article (2022) “Deducting Mortgage Interest When Your Name Is Not on the Deed“, you learned how such a Mortgage Interest Deduction is possible.
Do the same rules apply to claiming the $250,000 Home-Sale Exclusion? Pretty much, but not exactly, as we explain.
The Big Difference
Mortgage interest: IRS Reg. Section 1.163-1(b) states:
Interest paid by the taxpayer on a mortgage upon the 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.
Note the phrase “Legal or Equitable Owner.”
Home-Sale Exclusion: For the $250,000 ($500,000, if ﬁling jointly) Home-Sale Exclusion, IRC Section 121(a) states:
Gross income shall not include gain from the sale or exchange of property if, during the 5-year period ending on the date of the sale or exchange, such property has been owned and used by the taxpayer as the taxpayer’s principal residence for periods aggregating 2 years or more.
Note the phrase “Owned and Used.”
So What… What’s in it for You?
The IRS makes it clear that you can deduct mortgage interest if you have equitable ownership.
There’s no such clarity from the IRS that equitable ownership qualiﬁes the taxpayer for the Home-Sale Exclusion. That’s the bad news.
You will ﬁnd some good news in the Blanton case. But before we get to the good news, consider two points here:
- The IRS won the Blanton case.
- The case involved the former Section 121 home-sale exclusion. (We don’t think this is a big deal because the old Section 121 closely tracks with the new Section 121.)
You might ask: “If the Blantons lost this case, where’s the good news?” Good question.
The Answer: the court laid out factors that would qualify you for the Home-Sale Exclusion when your name is not on the deed, as follows:
- You have the right to possess the property and to enjoy the use, rents, and profits thereof;
- You have the duty to maintain the property;
- You are responsible for insuring the property;
- You bear the risk of loss of the property;
- You are obligated to pay taxes, assessments, and charges against the property;
- You have the right to improve the property without the seller’s consent; and
- You have the right to obtain legal title at any time by paying the balance of the purchase price.
You do not need to meet all the factors to qualify as the owner for purposes of the home-sale exclusion, but the more you meet, the better your chances.
Your son wants to buy a home but does not qualify for the necessary mortgage. You make the down payment and take out the mortgage. You ﬁle the proper gift-tax return and treat the down payment as a gift to your son.
Your son makes the mortgage payments, buys the insurance, and fully takes control of the home as its owner.
The son has you (remember, your name is on the deed) sell the home ﬁve years after you purchased it. The title company issues you a check for the sales proceeds, and you endorse the check to your son.
The title company reports the sale to the IRS and sends you a Form 1099-S. It’s messy, isn’t it?
First, if this is the result, you need to deal with the 1099-S reporting on your tax return, likely by reporting the amount so there’s a match with your Form 1040 and the IRS’s 1099-S copy. Then make a subtraction from the gross amount so the net on your return is zero.
If you can, however, do this differently. Buy the home for cash and sell it to your son using an installment sale. That eliminates the 1099-S mess.
Alternatively, if you need a mortgage, sell the home to your son using a contract for deed.5 Check with a good real estate lawyer to make sure such a sale does not trigger any due-on-sale clauses in the mortgage instrument.
The cleanest and best solution is to have your son buy the house. If the mortgage company needs a guarantee to make that happen, do it.
There’s a good chance that you will help your child buy his or her ﬁrst home.
The cleanest way to make this happen is to either (a) buy the home for cash and sell it to your child or (b) guarantee the mortgage loan to the bank.
The worst way is for your name to be on the deed and your child to be the owner. With this method, the tax documents the IRS receives carry your name, but your child is the one claiming the deductions. This can work, but it’s messy. And would you really want to explain this deal to the IRS?
It’s great that you’ll have a good chance of helping your child purchase their first home. I hope I’ve provided a path for you to pursue this.
If you have questions, need clarity, or need help determining how to navigate methods of the Home-Sale Exclusion to help retain or maximize your gains, please contact us at Morris + D’Angelo. This is our Expertise!
At Morris + D’Angelo, we believe that Tax Optimization is one of the most empowering and responsible things you can do to protect your growing financial assets. Tax optimization looks at a multi-year approach to minimizing tax costs. Tax avoidance is integral to tax optimization.
Parts of this article are published with permission from Bradford Tax Institute, © 2021 Daniel Morris, Morris + D’Angelo
Daniel frequently provides Media Content via Workshops, Podcasts, and Printed Articles on topics like Bitcoin and Cryptocurrency, Wealth Preservation and Planning, Global Banking, and many other high-level financial topics that serve and demonstrate the Value of our Global Network that should be of interest to those who need Private High-Wealth Services.
If you would like Daniel to speak to you or your Professional Group and bring clarity about the new frontier of the new business tax law changes. Please contact us.
Morris+D’Angelo is the industry leader for many High-Wealth Customers and Organizations.
503.749.6300 – Portland Office
408.292.2892 – San Jose Office