April 28, 2017

Tax & The Modern Homeowner

What was once considered a traditional household — a married father and mother with a couple of kids — is quickly becoming just one type of lifestyle. The number of unmarried people entering home ownership together is on the rise, and with it, a new set of tax issues to consider.

In the co-purchasing landscape, it’s vital to first consider which form of ownership works best for each individual, either as tenants in common or joint tenancy. 

  • Tenancy in common: With tenancy in common, owners are allowed to sell their own interest without the consent of the other co-tenants, which also means a co-tenant can’t sell or transfer the others interests. They share in the appreciation or depreciation value of the property, and are responsible for upkeep and maintenance costs according to their ownership interests. With tenancy in common there are no survivorship rights to the surviving owner.
  • Joint tenancy: With joint tenancy each individual equally owns an undivided interest and consent must be universally agreed upon whenever an action concerning the property is made.  In a joint tenancy agreement there are survivorship rights, and the property doesn’t need to pass through a will or enter probate.

Once ownership is established the owners receive the property title. If the property is transferred from one party to another — like in the case of survivorship — the new owner is given a deed.  Here are the two most common types of deeds:

  • Warranty deed: This is where the seller provides a number of guarantees to the buyer and gives a complete description of the property and buyer’s assets. It also assures a clear title free of liens and other potential issues.
  • Quitclaim deed: This is often used when the property is transferred through a will, gift or  part of a divorce settlement. There are no guarantees included, which can be tricky if the parties don’t know each other well or don’t have a trustworthy relationship.

Your home provides many tax benefits from the time you buy it right on through to when you decide to sell. Here are some common homeowner related tax deductions. 

  • Mortgage interest: Presently Sec. 163(h) allows homeowners to reduce their taxable income by the amount of interest paid on their real estate loan. Joint ownership does not always necessarily mean a joint mortgage. Generally you must be liable on the note to claim the interest deduction, however, if you can prove equitable ownership, you may be able to claim the deduction under Reg. 1.163-1(b). 
  • Real estate tax:  The legal owner or owners are generally entitled to a tax deduction for their property taxes. The differing forms of ownership and jurisdictions can affect the amount deductible by each owner. 
  • Indirect gifts: If one party pays property taxes on behalf of another property owner,  it can create a situation where it results in a gift from one party to another. In this situation the party who paid the entire tax bill can still only claim their portion of the deduction since they gifted the cash to pay for the other party.  

Other common tax issues:

  • A co-owner cannot  claim a mortgage interest deduction if they are not living in the residence unless the property is a second home or investment.
  • When unmarried co-owners sell their full or partial property interest to one another, it is still a taxable sale. However, the $250,000 homeowner exclusion may still apply to exclude the gain.   
  • When a casualty loss or theft occurs on a property, the deduction is divided on the basis of each individual’s portion of ownership.

This is just the tip of the iceberg of things to consider when venturing into a non-spousal homeowner agreement. Something that is vital to a stress-free partnership is to create a document that covers all aspects of your desired home sharing arrangement.  This includes a buyout strategy, decision to sell, refinance,  remodel, and what to do if one of the owners goes through bankruptcy or passes away.  

To achieve the most beneficial tax result, homeowners and their tax advisers should understand not only the tax rules but also how the home is financed, who owns the home, and who pays the home-related costs. Professional advice provided to the taxpayers before they enter into the transaction can significantly improve the tax results.