Co-Signing on a Mortgage? Here’s What it Means for Your Taxes

It’s not uncommon for parents or grandparents to call us about the possible impact on their personal taxes should they co-sign a mortgage with a child/grandchild.  This has become increasingly common in 2020 with plummeting interest rates.  It’s important to understand the obligations that come from agreeing to this as well as the possible negative impact on the cosigner.

Typically, someone is asked to cosign a mortgage for credit reasons; the individual looking to purchase a home has the financial means to do so but lacks the credit history for loan approval.  The higher credit score and additional income created by adding a cosigner makes a loan more appealing to lenders and their underwriters.

When it comes to cosigners, mortgage companies are looking for a few key factors: low debt-to-income ratio, stable income, and a good credit score.  An approved cosigner would appear on the mortgage application and other loan documents, but not typically on the property itself.  In other words, the cosigner does not generally have rights to the property.  They do, however, have an obligation to ensure that payments are made timely. This means that if the primary mortgage holder fails to make payments, the bank will look to the cosigner.

There are a few concerns that a cosigner should keep in mind before signing on the dotted line.  First, there is a risk to the cosigner’s credit score.  If payments go unmade, this will negatively impact the cosigner’s credit in addition to the primary mortgage holder’s.  Next, the cosigner’s debt to income (DTI) ratio is affected.  Even though the cosigner is unlikely to be responsible for making the mortgage payments, on paper the mortgage will appear as a liability for the cosigner.  Should the cosigner find him or herself in need of a loan, lenders will see the DTI as less attractive.  There is also the risk of creating a tense situation amongst family members.  If you decide to cosign for someone, we highly recommend that you have a very frank, business conversation about the realities of this agreement and possible outcomes.

What about taxes?

In short, you can cosign a mortgage without creating any impact on your personal taxes, though there is a risk to your credit and personal expenses.  However, for tax treatment, if your child takes sole responsibility for the home and expenses and your name is only on the mortgage as a formality, he/she can claim all the tax deductions from mortgage interest and property taxes paid.  Additionally, when the property is sold, all the proceeds from the sale can be solely on his/her return, thereby creating zero tax impact for the cosigner (so long as the seller maintained the property as a primary residence).

Alternatives to cosigning

Do you still want to help your child or grandchild purchase a home but find yourself unwilling to take on the risk of cosigning a mortgage?  There are a few alternatives:

Hold the mortgage yourself.  Some potential cosigners have the financial means to purchase the home themselves.  They could then rent the home to their child or owner finance the property until the child has the financial means to purchase it from the parents.

Down payment or closing cost assistance.  Sometimes a less than ideal credit situation for the purchaser can be remedied by increasing the closing costs contribution or down payment.  Often, however, the purchaser lacks the additional cash to do this.  Instead of cosigning, a parent could gift the additional funds to the child.  Remember that some gifts may create a need for a Gift Tax Return.  Alternatively, the parent could loan the child the additional funds.  Be sure to check with your financial advisor or CPA for specific rules and regulations regarding family loans.

Legal Considerations

There are important legal factors that should be considered before entering into this type of agreement.  What happens if one party passes away?  Who inherits the property?  Can the deceased’s estate be targeted by the mortgage holder?  What about different types of ownership?  Does one make more sense than the others?  Consult with your CPA, attorney or real estate professional to discuss how you could be affected.

Major Tax Reform Changes Affecting Homeowners

Are you a homeowner?  Here are some big changes under the new tax law that may have affected itemized deductions on your 2018 return (and one big item that was left unchanged!):

Mortgage Interest Tax Deductions

In prior years, homeowners could deduct interest on loan amounts up to $1 million.  Depending on the interest rate, the deductible amount could easily top $30,000+ in a given year.  Under the new tax law, that limit has been decreased to $750,000 which can result in a substantial decrease in the amount of interest a taxpayer can deduct.   The change in the mortgage interest tax deduction cap only applies to new home buyers.  If you purchased your home prior to December 15, 2017, you can still deduct the interest on loan amounts up to $1million.  If you are married and filing separately, you can each deduct half of the amount – $375,000 or $500,000 depending on date of purchase.

Home Equity Line of Credit (HELOC)

Many homeowners have historically used a HELOC to upgrade their homes or even pay other expenses unrelated to their property.  One of the benefits of this type of loan was that interest could be written off on the homeowners’ tax return.  Under the new tax law, interest on HELOCs is no longer deductible through 2025.  The only exception is if the loan is being used to “buy, build or substantially improve the taxpayer’s home.”  The portion of the interest related to these activities is still deductible.  Second homes or vacations homes do not qualify.

Property Tax

Property tax deductibility is also limited under the new tax law.  Previously, homeowners could deduct property tax paid in its entirety – regardless of amount or number of properties.  For individuals who owned large homes or multiple homes, the total amount deducted each year for property tax could be considerable.  The new tax law has limited this amount to $10,000 per year ($5,000 per spouse if married and filing separately).  There are no exceptions and it doesn’t matter when you purchased the home.

Moving Expenses

Former tax regulations allowed for the deduction of moving expenses if the move was considered work related.  Some limitations existed including distance of move and the amount of time worked during the first 12 or 24 months.  That deduction is now completely gone except for active duty service and military members.

Capital Gains Exclusion is Still Available

Good news!  One major benefit to homeownership remained untouched by the tax reform bill: the capital gains exclusion.  Married taxpayers who file jointly can still exempt up to $500,000 in capital gains from the sale of their home (the amount is $250,000 for single filers or married filing separately filers).  To be eligible for this exemption, the home must have been the taxpayers’ primary residence for 2 of the last 5 years (i.e. rental properties or vacation homes are not eligible).  A rough calculation of your capital gains on the sale of a property is:

Sale Price – (Original Purchase Price + Improvements)

For example, if you purchased a home for $150,000 and spent $50,000 in renovations over the years you called it home, your investment in the home would be $200,000.  If you sold the home for $525,000, a single filer would be able to exempt $250,000 of capital gains but would have to claim $25,000 in gains (525,000 – 250,000 = 275,000).  A married couple filing jointly could exempt the entire $275,000 in gains because it falls under the $500,000 limit.

If you’re a homeowner, remember that the key to saving at tax time is good records!  Make sure you retain copies of your closing statement from your original purchase and receipts for any major renovations or property improvements completed.  This will help appropriately calculate your basis, or how much you’ve invested into the home, at the time you sell.  Each year be sure to gather a copy of your property tax bill and 1098 (mortgage interest statement) for your tax preparer.  These can amount to sizeable deductions and a reduction in your tax liability.  We recommend keeping all home-related records for the length of time you own the property plus seven years.

Questions about how these changes may affect you?  Levesque & Associates is happy to help!