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About 5 years ago I agreed to help a family member. I signed

About 5 years ago I...
About 5 years ago I agreed to help a family member. I signed for the mortgage and have been deducting the intersest, points, taxes, etc while he has been paying me the house payment to forward to the bank. After the first year I refinanced and pulled out some equity to help pay some personal debt. I thought I understood what I was doing, but it now turns out I should have either reported the payments as rental income and tried to depreciate the property to offset the income, or should not have used those items on Sched A to reduce my taxable income... Is there an easy answer for how I go about fixing this while minimizing the impact of the back taxes?
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Answered in 2 minutes by:
6/9/2013
Stephen G.
Stephen G., Sr Income Tax Expert
Category: Tax
Satisfied Customers: 7,245
Experience: Extensive Experience with Tax, Financial & Estate Issues
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Stephen G :

Hi & thanks for using our service. I'll do my best to give you a complete & accurate answer. Please ask me to clarify anything that is not clear.

Stephen G :

Who owns the property? Who is on the deed?

Customer:

I am individually listed on the deed.

Customer:

The 'plan' was to do this for a year or 2 until he could refi and purchase in his/his wife's name. Unfortunately this went on for several yrs and now he's offering to do a land contract to add himself to the deed, then refi in a yr to take sole possession.

Stephen G :

Unfortunately, there is no easy way to set the record straight on this. You would need to file amended returns.

Customer:

And, sorry, thanks for your help.

Stephen G :

How is this coming up as an issue?

Customer:

Can you recommend either filing the house payments as income, or as adjusting the claims for the interest ,points, etc?

Customer:

When we first worked this out, he suggested (and I failed to clarify with experts) that I could deduct the interest, etc. Now, in doing the land contract his advisor suggests I should amend and not claim any of these items.

Stephen G :

I'm wondering whether or not perhaps his payments to you were in effect a down payment on the purchase of the property?

Stephen G :

How are you determining what you are going to sell the property for?

Customer:

To start with he paid my $10k to execute this. I"ve claimed all interest, etc for taxes. We were planning to have him refi after the land contract was established for payoff value on the note.

Stephen G :

So, in effect, since he is a family member that you were trying to help out, you are selling him the property for what you paid for it, plus the 10K, plus the carrying cost of the property until he is able to close on taking over the property from you.

Stephen G :

To you see what I am driving at?

Customer:

Yes.

Customer:

Not exactly... at least how it translates to the taxes I've already filed...

Stephen G :

Since you are dealing with a family member, you didn't enter into the arrangement for profit, I'm not sure treating the property as a rental property is correct either.

Customer:

ok

Stephen G :

If you were to treat the property as a second home; occupied by a family member, all that interest would be properly deductible.

Customer:

so in short, I've done nothing 'wrong' as far as IRS should be concerned?

Stephen G :

You would add up all his payments to do and include that and the 10K, and anything else as the selling price of the property.

Customer:

if it matters, this is the only property i own/have a mortgage on

Stephen G :

In order to have done nothing "wrong", you need to re-characterize his payments to you. They can't be reimbursement for interest and principal.

Customer:

ok

Stephen G :

Realize, that he shouldn't have deducted the payments.

Stephen G :

He doesn't own the property and he isn't obligated on the mortgage.

Stephen G :

What happens is that you will turn these payments he made to you to capital gains when you transfer the title to him.

Customer:

Adding him to the deed for the land contract to allow him to obtain a new mortgage, then remove me from the deed to 'transfer' the property to him is consistent with how we're treating the property?

Customer:

oh ok

Stephen G :

Well, I'm not sure that is the way to do it; you need to sell the property to him and report the transaction as a sale in order to be consistent with how I'm suggesting you handle the payments he made to you in order to leave everything with respect to your returns as is.

Customer:

Understood. And is there any issue with the fact that this is the only property I own?

Stephen G :

No.

Customer:

Awesome. THank you very much!

Stephen G :

If you need to contact me again with any tax or financial questions, you can just ask for "Steve G" at the beginning of your question. Again, please remember to rate my response. Bonuses, where you think they are warranted, and excellent ratings, are always most appreciated. Thanks again for using JustAnswer.com.You may get a short survey from the site; if it isn't too much trouble I would appreciate it if you would answer it; the survey results are used to rate our performance;

Stephen G :

Please remember to rate my response; this is the only way we get credit for our work. Thanks very much.

Stephen G.
Stephen G., Sr Income Tax Expert
Category: Tax
Satisfied Customers: 7,245
Experience: Extensive Experience with Tax, Financial & Estate Issues
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Stephen G.
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