I do quite a bit of estate work here in Denver, and because of my title experience as a landman I often find the loans, deeds and other documents are un-intentionally fowled up by well meaning relatives. Also, we can often pass interests at the wrong time to our loved ones creating further taxable issues See my previous post about the basis of the "Inherited Real Estate". But more often we find mom & dad "loaning" the kids some money to buy the house, collecting interest, and the kids NOT being able to deduct that interest. Read on...
Occasionally, when dealing with close relatives who might also become heirs, signing a note and handling the paperwork properly may seem like a needless effort but it could mean the difference in being able to take a legitimate interest deduction.
Home mortgage interest is deductible only if the loan is a secured debt which involves the buyer signing an instrument like a mortgage or deed of trust that makes the ownership of the home security for the debt. That instrument must then be recorded or otherwise perfected according to state or local law and the home, in case of default, must be able to satisfy the debt.
In a family situation, a parent, grandparent or other relative may decide to loan a buyer the money to purchase a home because they have it available and it isn’t earning much in certificates of deposit. They offer to loan it for a rate equal to what a conventional lender is charging but without the fees.
While it may appear to be a win-win situation, there could be problems if things are not done correctly. Even if the borrower makes the payments, they are not entitled to an interest deduction unless three criteria are met: 1) sign a debt instrument specifying the terms 2) securing and record the debt properly and 3) the home is sufficient collateral for the loan.
It would be prudent to consult with an attorney before you sign the final settlement papers to be comfortable that both buyer and the lender-relative are complying with IRS regulations. For more information, see IRS Publication 936 – Home Mortgage Interest.
There are all kinds of attorneys with all kinds of specialties. If you need one that is 100% focused on real estate here in Denver to help you preparing loan documents or even mineral severance deeds, let me know so I can introduce you.