Deducting Mortgage Interest

One of the issues divorcing couples overlook most often is who’s going to deduct what amount of the mortgage interest and property taxes they paid on the house where they lived together. They’ll surely remember it, though, a few months later when it’s time to file their tax return. Time for another fight. Time to get their lawyers involved again, spend some more money, and drive up the tension. Yuk.

You don’t want to be there, do you?

The way to keep it from being an issue is to work it out now, in advance, and include it in your divorce settlement agreement. The problem is that your lawyer probably won’t think of it; most lawyers don’t. It’s really up to you.

What happens if you don’t work it out?

This is where most couples at least start out. Most of them work it out eventually (before they file their tax returns). But occasionally, they keep fighting over the deductions. Here’s the way it gets played out:

If you and your spouse don’t agree on who should take the deductions, your respective tax advisors (more and more, for most of us, that’s ourselves) will encourage each of you to take the full amount of the deduction. That means that, between the two of you, you’re deducting twice as much interest and taxes on the house as you’re allowed to take.

There’s always a possibility that this will slide through the cracks and that the IRS will allow it. Don’t count on it. The IRS uses a data match system that compares what you and your spouse claim on your tax returns to the amount that has been reported by the holder of your mortgage and your local government on Forms 1098. If there’s a discrepancy, the IRS will ask both of you for an explanation. In the ensuing weeks (months?) (years?), you and your spouse will both make your best case to the IRS and attempt to convince them that your position is correct.

You may end up paying your lawyer or your accountant to help you deal with the Service, and you may end up in an 8 x 10 cubicle getting to know your not-so-favorite bureaucrat. Eventually, the Service will allow or disallow some or all of the deductions each of you has claimed based on its interpretation of who has the right to claim them.

Who Has the Right?

First let’s deal with some myths.

  • The right to claim the deductions does not follow the person who ends up eventually owning the house.
  • The right to claim the deductions does not just go half and half to each of the joint owners.

Instead, the right to claim the deductions goes to the person who can show that he or she paid the expenses out of his own funds. If neither of you can prove that you paid the expense from your own separate funds, the IRS probably will conclude that each of you is entitled to half of it.

If you want authority and a real-life example, you can take a look at Rev. Rul. 71-268, 1971-1 C.B. 58.

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