Q: I found a house that I want to buy and the plan is to borrow the money from a family trust. I will live in the house with my family. My older brother is the trustee and he has already said that he will approve the loan, so I can get the loan funded immediately without any credit approval delay. I can also avoid an appraisal of the home. My only issue to still resolve is to make sure that I can deduct the interest on the loan. This is not a gift – I will repay the loan over 15 years at 2.75% interest. The trust has several of the family as beneficiaries and my brother has made it clear that the trust must be repaid. So I need to know if the fact that a bank is not the lender makes any difference in my ability to deduct the interest?
A. No it does not. The identity of the lender has no effect on the deductibility of interest. There may be fact patterns where a family relationship raises a question about the bona fide nature of the loan, but you strongly suggest this is a bona fide loan.
You can deduct the interest if it qualifies as paid on “qualified residence debt.” Qualified residence debt includes a loan to acquire a residence provided the principal on the loan does not exceed $1 million and the loan amount does not exceed the fair market value of the home.
A final requirement is that the loan be secured by the residence and the security interest be perfected under the requirements of local law. This would require that the loan be recorded.
Because your brother has a fiduciary responsibility to the other trust beneficiaries, he would be expected to use a note and mortgage, and to record the mortgage.
Provided you use this house as a residence and there is a recorded mortgage, you can deduct the interest on schedule A of your return (as an itemized deduction). Note that I am assuming that the loan amount will not exceed $1 million or the fair market value of the house.
Q: My wife retired from the state of New Mexico on Sept. 1, 2012. In applying for retirement, she filled out the Public Employees Retirement Association (PERA) of New Mexico form titled “Application for Pension Form.” In the “Beneficiary Designation and Form of Payment” section, we decided she would check the block for a Straight Life Option for her lifetime only and payments stopped upon her death. She was diagnosed with pulmonary fibrosis, a terminal illness. She also had extensive heart damage as a result of the pulmonary fibrosis, which necessitated a pacemaker. We lost her to the illness a year ago, January 2015. During her years of employment with the state of New Mexico, $26,305 was taken from her pay, after tax, for her retirement. She received four retirement payments in 2012, 12 payments in 2013, 12 payments in 2014 and one payment in 2015, a total of 29 payments. Her last payment for January 2015 was $1,295. The Simplified Method Worksheet was used to calculate the taxable amount of her retirement income. $405 was recovered in 2012, and $1,503 was recovered in 2013 and 2014. The total recovered is $3,411. $22,894 has not been recovered ($26,305-$3,411). I am preparing our 2015 tax return and need to know what to do with the $22,894 unrecovered cost. Also, am I required to file “single” when I file the 2016 tax return?
You properly used an annuity exclusion ratio, which is based on life expectancy, to recover the after-tax cost of her PERA contract.
Because it’s based on life expectancy, it is a “guess” that must be adjusted when the payments don’t match the estimate.
The unrecovered basis is a deduction on the 2015 return. It is a miscellaneous itemized deduction, but is not subject to the 2 percent of AGI calculation.
You could just call it “unrecovered basis in annuity.” Make sure it goes on line 28 of schedule A so it is not reduced by 2 percent of AGI.
And you will file single in 2016 (but MFJ in 2015).
James R. Hamill is the director of Tax Practice at Reynolds, Hix & Co. in Albuquerque. He can be reached at firstname.lastname@example.org.