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I am fully "financially responsible" for a property in the United States that is not in my name. I made arrangements with the previous owner to take over payments on the property and assume full ownership rights to the property until I had paid enough to be considered a "down-payment" to a lender. I make all the payments, pay the taxes, fund repairs and improvements, and oversee everything to do with the property, and have done so for over three and a half years. Last year I moved off the property and rented it to someone, and I need to claim the income from it. I was told by a tax preparer that they didn't think I could claim the income from the house, nor could I claim the interest paid on the mortgage. What is the law concerning this?

  • Which country are you in? Also, do you have any legal rights to the property? – Timo Geusch Feb 24 '11 at 18:47
  • @Timo Geusch - Edited question to include country (United States). Not sure how to answer the question of legal rights. An agreement (from my understanding) between two parties is legally binding, and I have an agreement to be financially responsible for the property. I do not, however, hold a deed or any portion of the title. My answer would be "Yes, I have legal rights to the property." I'm just not sure how the IRS views it. – Nathan Wheeler Feb 24 '11 at 19:08
  • I'm not a lawyer but my understanding would be that you might have an agreement to pay for the property (which hopefully is in writing, legally binding and all that) but you have no legal rights to the property and no beneficial interest in it because basically there is no legal agreement or record that you actually own (part) of the property. And if that doesn't exist I would think that how the IRS views the undertaking might be the least of your problems; to me it sounds like you have all the downsides of home ownership with not much of the upside (yet). – Timo Geusch Feb 24 '11 at 20:43
  • Yeah, I know... I'm getting it financed in my name this year, hopefully in just a couple months. There's a section of the back of the house that needs to be repaired (board and batten exterior, small section decaying from water splash) and after that's done I'm going to have it appraised and financed. I'm supposed to have the wood (delivered tomorrow) and get it repaired in the next week or so (depending on the weather). – Nathan Wheeler Feb 24 '11 at 20:49
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First off, I'm not an accountant. I do know enough though that based on what your accountant told you, you should be talking to a different accountant.

Since you don't actually have legal ownership of the property - neither the deed or the mortgage are in your name, I would treat this as a lease/sublease situation as stoj suggested. So, you are leasing the house from the current owner and subleasing it to someone else.

For tax purposes though, I would disagree with stoj a bit:

  1. You should claim all the rental income as income.
  2. You should claim the ENTIRE mortgage payment as an expense (principal & interest) just as if you were paying that money as a lease payment.
  3. Since you don't own the property, you can't depreciate it, but you can (and must) claim depreciation on any leasehold improvements you may have made since you started renting the place (new carpet, appliances, etc.)
  4. You should claim any other expenses you have related to the property (insurance, property taxes, any utility bills you may pay, etc.)
  • +1 Good answer. Note that he said "tax preparer" -- you're right that talking to someone more qualified is a good idea. – bstpierre Feb 25 '11 at 3:50
  • The problem with claiming the principle as an expense is that it isn't an expense it is part of a down payment a capital expense and should be amortized over the useful life of the property (27.5 yrs). Expensing the principle now means it will essentially be deducted twice unless the OP doesn't buy the property and looses out on the principle paid in which case it should be deducted as an expense. – stoj Feb 25 '11 at 4:16
  • @stoj - but he doesn't own the property, so he can't depreciate it. The current owner would take the depreciation since technically he is the one actually paying the mortgage. When md5sum actually legally purchases the property then his basis would be calculated based on the actual purchase price (minus land). – Eric Petroelje Feb 25 '11 at 12:34
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Assuming rental payments are made to you and you paid money toward expenses. You have a legal responsibility to claim the income on your taxes as well as the associated expenses it's just that your situation doesn't fit into the tax preparers neat little boxes. The way to proceed depends on how your interest in the property is documented and who you pay money to in this arrangement.

Income and expenses for rental property should be included on schedule E or schedule C depending on how involved you are in the rental property. Figuring out expenses will probably be a little tricky and depends on how the payments you are making are classified. I would classify the amount you pay minus the amount of equity you are getting as the cost of renting the house from the current legal owner. Basically treating the situation as if you are subleasing the house. I would also write off the cost of repairs as normal rental repairs, I get the impression you do most things yourself so it would be the material costs associated with repairs. If you made improvements things get a little more tricky.

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