Equitable Owner Equals Deduction

BY CHARLES J. REICHERT

The Tax Court held that a married couple could deduct mortgage interest and property tax payments made from a corporate checking account on a home that was owned by their son. The court held that the taxpayers were equitable and beneficial owners of the property and that the checking account was in essence their personal account. Thus they were entitled to itemized deductions for the payments.

Taxpayers may deduct interest paid by them on debt related to a qualified residence. Generally, the debt must be the taxpayer’s, not someone else’s. Treas. Reg. § 1.163-1(b) permits a deduction for interest paid on a mortgage when a taxpayer is the legal or equitable owner of the property, even though the taxpayer is not directly liable for the mortgage. In Saffet and Ana Uslu v. Commissioner, TC Memo 1997-551, the Tax Court held that a married couple was the equitable owner of a home titled to the husband’s brother since, from the date of acquisition, they had occupied the home and made all payments for the mortgage, taxes, repairs, maintenance and improvements. In Bruce D. Loria v. Commissioner, TC Memo 1995-420, the same court held that the taxpayer was unable to demonstrate that he was the equitable owner of a home owned by his brother—thus denying deductions for interest and property taxes.

In the instant case, Ndile George Njenge and Ekinde Sone Nzelle Rachel resided in a home owned by their son. In 2001, their son purchased the home in his name since the taxpayers were unable to obtain financing; however, from the date of acquisition until the date of the trial, Njenge and Rachel made all of the mortgage, property tax and maintenance payments and were the sole occupants of the home. In 2003, the taxpayers paid those housing costs from a checking account of a company called Camrock General Engineering Co., an entity for which the taxpayers had established a bank account but never actually formed or started and did not intend to do so in the future. The IRS disallowed the mortgage and property tax deductions for 2003, causing the taxpayers to petition the Tax Court for relief.

The IRS argued that no deduction for interest and taxes should be allowed since Njenge and Rachel were not the legal owners of the property and were not legally obligated to make any payments. Furthermore, the IRS argued that Camrock had made the payments, not the taxpayers. The court rejected both arguments, holding Njenge and Rachel were the equitable owners of the property since, from the date of acquisition, the taxpayers were the only ones who enjoyed the benefit and bore the burden of the home. Furthermore, the court found that the Camrock checking account was in essence the taxpayers’ personal account.

This case illustrates that the economic substance rather than the legal form of a home ownership situation can dictate the tax result. In this case, it is important to note that the taxpayers prevailed because the evidence suggested that their son was owner in name only and that the “business,” whose name was on the checking account used to make the housing payments, existed in name only.

Ndile George Njenge and Ekinde Sone Nzelle Rachel v. Commissioner, TC Summary Opinion 2008-84

By Charles J. Reichert, CPA, professor of accounting, University of Wisconsin–Superior.

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