Mortgage interest follows liability and the source of payment

Plain-English summary

Chief Counsel addressed how taxpayers should divide a mortgage interest deduction when more than one person is liable on the loan. If interest is paid from a joint account owned equally by two people, each is presumed to have paid half unless evidence shows otherwise. A person who is jointly and severally liable may deduct the interest that person actually pays from separate funds, assuming the interest otherwise qualifies. For the year one spouse dies, the decedent's return includes deductible interest through death under those payment rules, while the surviving liable spouse may deduct later payments. Unmarried co-obligors and related co-owners use the same approach, and an equitable owner who is not directly liable may sometimes qualify under Treas. Reg. § 1.163-1(b). The name or Social Security number shown on Form 1098 does not by itself decide who is entitled to the deduction.

Ruling snapshot

• Question: How should co-obligors and co-owners allocate the mortgage interest deduction when payments come from joint or separate funds?
• Outcome: Advice given
• Key authorities: IRC § 163; Treas. Reg. § 1.163-1(b); Rev. Ruls. 59-66, 71-179, and 71-268

Full text (IRS public release)

       Office of Chief Counsel
       Internal Revenue Service
       memorandum
       Number: 201451027
       Release Date: 12/19/2014
       CC:ITA:B03:SLHall                       Third Party Communication: None
       POSTS-119053-14                         Date of Communication: Not Applicable

UILC: 163.00-00

date: October 01, 2014

 to:   Nancy C. Carver
       Associate Area Counsel (Denver, Group 1)
       (Small Business/Self-Employed)

from: Christopher F. Kane
Branch Chief, Branch 3
(Income Tax & Accounting)

subject: Mortgage Interest Issues

       This Chief Counsel Advice is in response to your request for assistance regarding cases
       involving the deduction for mortgage interest under section 163 of the Internal Revenue
       Code. This advice may not be used or cited as precedent. You ask that we consider the
       following fact patterns:

       Situation 1. Taxpayers are a married couple and are jointly and severally liable on a
       mortgage, but one spouse is deceased at the end of the taxable year and the bank issues
       a Form 1098 under the deceased spouse’s social security number. The surviving spouse
       files a separate return. Payment may be made from a joint account or from separate
       funds of either taxpayer.

       Situation 2. Taxpayers are an unmarried couple and are jointly and severally liable on a
       mortgage, and the bank either issues a Form 1098 under only one social security number,
       or both. One or both taxpayers claims the mortgage interest deduction on their individual
       returns. Payment may be made from a joint account or from separate funds of either
       taxpayer.

       Situation 3. Related persons co-own a house and are liable on a mortgage note. A bank
       may issue a Form 1098 under the name of one or both of the co-obligors. Each taxpayer
       claims 50% or 100% of the deduction. Payment may be made from a joint account or
       from separate funds of either taxpayer.

POSTS-119053-14 2

In particular, you asked that we consider the analyses in PLR 5707309730A, 1957 WL
12580, and Neracher v. Commissioner, 32 B.T.A. 236 (1935).

PLR 5707309730A took the position in an instance where a husband and wife were filing
separate returns, that when funds were paid from a joint bank account owned by both
spouses for medical and dental expenses, each spouse was considered to have paid one
half of the amounts paid from the account. The ruling states, “Where [taxpayers] maintain
a joint checking account in which each apparently has an identical interest with the other,
there is a presumption that items paid from such account are paid equally by each of the
two parties. “

PLR 5707309730 cites Mark B. Higgins v. Commisioner, 16 T.C. 140 (1951), where a
husband was allowed to deduct only one half of the interest paid from a joint bank account
on a mortgage on property held by the husband and his wife as tenants by the entirety. In
Higgins, rental income relating to the property was deposited into the joint account, and
the husband wrote a check on the account to pay the interest. The court determined that
he was not entitled to deduct all the interest on his separate return because he had not
established that the interest was paid from his separate funds.

In Finney v. Commissioner, T.C. Memo. 1976-329, husband and wife taxpayers owned
property as tenants by the entirety and were jointly liable on the mortgage. Payments
were made by check on a joint account by the wife, who claimed she was entitled to one-
half the interest deduction. However, the court allowed the entire deduction to the
husband, noting that both taxpayers stipulated that the funds used to make the payments
were supplied by the husband.

The court stated:
“Under normal circumstances, a deduction in respect of payment of a joint obligation is
allowable to whichever of the parties liable thereon makes the payment out of his own
funds. Al Jolson, 3 T.C. 1184, 1186 (1944); F. C. Nicodemus, Jr., 26 B.T.A. 125 (1932);
William R. Tracy, 25 B.T.A. 1055, 1061 (1932), revd. on another issue 70 F.2d 93 (6th Cir.
1934). See Mark B. Higgins, 16 T.C. 140, 143—144 (1951). See also Rev. Rul. 71-268,
1971-1 C.B. 58. The authorities are sparse, however, where payment is made by one
such party out of funds provided by the other. In Edward C. Kohlsaat, 40 B.T.A. 528
(1939), the taxpayer deeded property to his wife as part of a divorce settlement but
remained primarily liable on the mortgage debt, which the wife did not assume. Pursuant
to a separation agreement, he was required to, and did, provide her with funds for the
express purpose of paying the mortgage interest. Under these circumstances, the Court
held that the wife was acting merely as the husband's agent in respect of the payment of
the interest and that he was entitled to the deduction therefor. In Mark B. Higgins, supra,
the Court held that the taxpayer husband was only entitled to deduct one-half of the
interest paid in respect of a mortgage on property held by him and his wife as tenants by
the entireties. In so holding, the Court emphasized that the payments were not made ‘from
separate funds'. See 16 T.C. at 143. Compare Deininger v. Commissioner, 313 F.2d 221,
POSTS-119053-14 3

224 (4th Cir. 1963), revg. on other issues T.C. Memo. 1961-212; Rev. Rul. 62-38, 1962-1
C.B. 15. “

In addition, Rev. Rul. 59-66, 1959-1 C.B. 60 holds that amounts paid for the medical care
of a taxpayer, her husband and their son and daughter, from funds deposited in a joint
checking account in which the husband and wife apparently have an equal interest are, in
the absence of competent evidence to the contrary, presumed to be paid equally by the
husband and wife for the purpose of computing the deduction allowable under section 213
when the husband and wife elect to file separate Federal income tax returns.

Based on these authorities, we conclude that funds paid from a joint account with two
equal owners are presumed to be paid equally by each owner, in the absence of evidence
showing that is not the case, as reflected in PLR 5707309730A.

In Neracher v. Commissioner, 32 B.T.A. 236 (1935), a taxpayer paid all the interest on a
mortgage on which he was a joint obligor although his wife owned the mortgaged
property. The court ruled the taxpayer was entitled to deduct the entire amount of interest
paid on his separate return. The court did not consider the issue of whether payment of
the funds was from a separate account of the taxpayer.

In Larson v. Commissioner, 44 B.T.A. 1094, (1941), the court concluded that a cosigner
on a note was permitted to deduct interest. The taxpayer and her son signed notes as co-
makers that were obtained entirely on the credit of the taxpayer, and the proceeds were
turned over to her son. The Service argued that the obligations were incurred only by the
son, not the taxpayer and that interest paid by the taxpayer was therefore not deductible.
The court, however, held that the taxpayer’s obligation as co-maker of the notes was both
joint and several, and that “The notes were at all times her personal obligations and
amounts paid by her as interest must be considered interest paid on her indebtedness,”
citing Neracher. In Castenada-Benitez v. Commissioner, T.C. Memo. 1981-157, a
taxpayer paid interest on a mortgaged secured by the marital residence which was owned
jointly by the taxpayer and his former wife. The Service disallowed half the interest, but
the court allowed the deduction, stating that “A deduction in respect of the payment of
interest on a joint obligation is allowable to whichever of the parties liable thereon makes
the payment out of his own funds. … Inasmuch as it is clear here that petitioner made the
home mortgage payments and respondent does not challenge the fact that he was an
obligor on the mortgage, petitioner is clearly entitled to deduct the full amount of the
stipulated mortgage interest paid …” Castenada-Benitez at 157 .

In Rev. Rul. 71-179, 1971-1 C.B. 58, a father is allowed to deduct interest on a student
loan agreement that he co-signs with his son. In Rev. Rul. 71-268, 1971-1 CB 58, when a
husband and wife are jointly and severally liable for payment of interest on indebtedness
on property held as tenants by the entirety, and the husband makes seven payments
during the year while the wife makes five payments during the year, the amount of interest
actually paid by each is deductible on their separate income tax returns.
POSTS-119053-14 4

Based on these authorities, we conclude that the rule that a person who is jointly and
severally liable on an indebtedness is entitled to deduct all the interest on the
indebtedness provided that person actually pays the interest, remains a valid rule to the
extent that the interest is otherwise deductible, as determined in Neracher v.
Commissioner, supra.

Regarding the specific factual situations described in your request, we believe the
following to apply.

Situation 1. Taxpayers are a married couple jointly and severally liable on a mortgage,
but one spouse is deceased at the end of the taxable year and the bank issues a Form
1098 under the deceased spouse’s social security number. The surviving spouse may
file a separate return. Payment may be made from a joint account or from separate funds
of either taxpayer.

In the year of death, if the surviving spouse files a separate return, the decedent’s return
should include income and deductions to the time of death. In determining the amount of
interest deductible on the decedent’s return, the principles discussed above regarding
payment from joint or separate accounts, and joint liability should apply. For example, if
the decedent paid interest from a joint account before death, the decedent’s return should
reflect one-half of the interest paid from the joint account before the time of death, in the
absence of evidence that the interest was paid from the decedent’s separate funds. In
years following the year of death, the surviving spouse is entitled to the deduction for
interest since the surviving spouse is liable on the note, assuming the surviving spouse
makes the interest payments and all other requirements are met.

Situation 2. Taxpayers are an unmarried couple and are jointly and severally liable on a
mortgage, and the bank either issues a Form 1098 under only one social security number,
or both. One or both taxpayers claim the mortgage interest deduction on their individual
returns. Since both taxpayers are liable on the mortgage both are entitled to claim the
mortgage interest deduction to the extent of the mortgage interest paid by either taxpayer.
If the mortgage interest is paid from separate funds, each taxpayer may claim the
mortgage interest deduction paid from each one’s separate funds. If the mortgage
interest is paid from a joint bank account in which each has an equal interest, under Rev.
Rul. 59-66, it would be presumed that each has paid an equal amount absent evidence to
the contrary.

Situation 3. Various combinations of relatives may co-own a house and be liable on a
mortgage. A bank may issue a Form 1098 under the name of one of the co-obligors, or of
both co-obligors; taxpayers may claim 50% or 100% of the deduction. Payment may be
made from a joint account or from separate funds of either taxpayer.

In general, to claim an interest deduction it is necessary to be liable on the note.
However, section 1.163-1(b) states that “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
POSTS-119053-14 5

directly liable upon the bond or note secured by such mortgage, may be deducted as
interest on his indebtedness.” Under several tax court cases, Uslu v. Commissioner, T.C.
Memo. 1997-551 and Amundsen v. Commissioner, T.C. Memo. 1990-337 a taxpayer was
permitted to deduct interest on indebtedness even though the taxpayer’s family member,
such as a sibling, was liable on the indebtedness, rather than the taxpayer. In such a
case the taxpayer must show that they are the equitable owner of the property based on
all the facts and circumstances. In general, if co-owners of a house are both liable on a
mortgage, each one may take a deduction for the amount each one pays
subject to the limitations and requirements of section 163(h). Neracher v. Commissioner,
supra.

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writing may undermine our ability to protect the privileged information. If disclosure is
determined to be necessary, please contact this office for our views.

Please call (202) 317-5100 if you have any further questions.