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.

Love Letter from the IRS? Don’t Panic!

Are you one of the lucky tens of thousands of American taxpayers who received a letter in error from the IRS?  If so, don’t panic!  According to Richard Neal (House Ways and Means Committee chairman, D-Mass), there were roughly 12 million pieces of unopened mail in IRS offices across the country.  This was the result of many IRS workers working from home during the pandemic.  In those enormous piles of mail are paper tax returns, correspondence, and (you guessed it!) tax payments.

The IRS has started sending out letters to address unpaid balances.  The problem is that many of those tax payments were mailed, they just remain unopened.  As taxpayers receive these letters, they panic.  However, there is no need to panic!  If you mailed a check to the IRS the first thing you should do is check your bank account.  Has the payment cleared?  If not, then there is nothing for you to do but wait.  Clarification letters are being sent out as payments are processed.  If your check has cleared and you still received the letter, we recommend calling the IRS to discuss the payment with a representative.  It may be a clerical error or the letter may have been sent before the payment was processed.

Have you received a letter from the GA Department of Revenue or another state’s taxing authority?  The first step is to call and request an explanation of the penalty.  There are two likely causes:

  1. Your payment was received after the typical April 15th deadline but before the July 15th deadline.  If the state’s system was not updated to recognize the new filing deadline this year, you may have been assessed a penalty even though your payment was not late.
  2. You had a sizeable balance due and are being penalized for failure to make estimated payments.

Why would you be penalized for not making estimated payments?  Remember that our tax system is a pay-as-you go system meaning tax is due when it is earned.  This is why W-2 employees have taxes withheld from each paycheck.  If your balance due at filing is greater than $1,000, both the IRS and state taxing authorities reserve the right to calculate a penalty for failure to make estimated payments.  For more information on estimated payments, check out our previous blog post.

Were you owed a refund that you have not yet received?  The IRS has announced that it will pay refund interest on any return filed before the July 15th deadline and that interest will be calculated from April 15th.

Recovery Rebates (aka Stimulus Payments) Explained

As part of the Coronavirus Aid, Relief, and Economic Security (CARES) Act, Congress approved a stimulus payment plan that may provide direct cash payments to taxpayers. The stimulus payments are considered advanced rebates of a refundable credit against taxpayer’s 2020 tax return. The recovery rebate advance amounts have been quoted as differing amounts, but we’ll try to explain how much taxpayers can expect to receive. While there are many moving parts related to the recovery advances, we know for sure the maximum amounts that taxpayers can expect to receive.

The refundable credit per taxpayer over the age of 17 that is not claimed as a dependent is up to $1,200. This means that a married couple can receive up to $2,400. In addition to the taxpayer amount, a rebate of up to $500 per child under the age of 17 is provided for in the bill. In other words, married taxpayers with 3 children can receive up to $3,900. However, take note that I’ve used the term “up to” quite a bit already. This is because the bill was written to phase out the rebates based on taxpayers adjusted gross income. The limitation is based on the AGI claimed on the most recently filed tax return, which will be the 2019 tax return for most taxpayers. Note, adjusted gross income is used as the basis for calculating the recovery rebates, not gross income.

As mentioned before, the mechanics of the rebate are going to be challenging. First, the payment is going to be made based on your 2018 or 2019 tax return (whichever was most recently filed). However, whether the payment is tax free, somewhat taxable, or wholly taxable is going to be dependent on your 2020 tax return. This means that the amount being paid directly to taxpayers could be subject to tax if 2020 adjusted gross income is over the credit thresholds. Now, let’s get into the actual numbers of the bill.

Remember, the payment is up to $1,200 per eligible taxpayer, and $500 per qualifying child. The AGI phase-outs begin at the following thresholds:

  • Married Filings Jointly: $150,000
  • Head of Household: $112,500
  • All Other Filers: $75,000

Additionally, AGI over the threshold amount will start reducing your payments. The reduction amount is $5 for every $100 over the applicable threshold.

The first step in the process is to calculate the max household payment. Let’s use a married couple, filing jointly, with 2 kids as an example. Their payment would be up to $3,400 (1200 + 1200 + 500 + 500).  However, taking into account the fact that the AGI on their most recently filed return is $175,000, we realize that their stimulus amount will be reduced because the phase-out begins at $150,000. In this case, we would reduce the payment by $1,250 (25000 x .05). This couple’s total recovery rebate would be $2,150.

Let’s break down the math:

Married filing jointly = $1,200 per taxpayer or $2,400 total

2 kids under the age of 17 = $500 per child or $1,000 total

AGI over phase-out = $175,000 – $150,000 = $25,000

AGI-based reduction of rebate = [25,000 x .05]   OR  [(25,000 / 100) x 5]

So….  (2400 + 1000) – (25000 x .05) = $2150

Let’s look at another example. A single taxpayer without any children and an AGI of $60,000 would expect to receive up to $1,200.  The threshold for single filers is $75,000.  Because their AGI is below the threshold, they should expect to receive the full $1,200.

Here’s one more example.  A single taxpayer with a 16 year old child.  This person would expect to receive a rebate of $1700 ($1200 + $500).  With an AGI of $80,000, they are over the single filer limit.  However, there is a higher limit for head of household filers ($112,500) so they should expect to receive the full $1,700.  If we use this same example and the taxpayer has an AGI of $115,000 on their most recent tax return, they would receive a reduced rebate.  In this case, the total amount received would be $1,575.

$115,000 – $112,500 = $2,500

$2,500 x .05 = $125 (reduction)

$1,700 – $125 = $1,575

Simply put, the rebate is going to be based on your filing status plus the number of children you claim under the age of 17. Any AGI over the applicable threshold will reduce the total payment by 5% of the applicable overage.

How do I find my AGI?

Want to calculate your own payment?  The first thing you’ll need is the AGI from your most recently filed tax return (2018 or 2019). While each form is different, AGI can be seen on line 8b of the 2019 Form 1040.  Just remember that AGI may be listed on a different line if you’re not utilizing form 1040.

When can I expect my refund? And where are they going to send the check?

Rebates are expected to be sent out, according to the US Treasury, within the next three weeks. Checks will be sent to the last known address (i.e. the address on your most recent tax return) or via direct deposit. If you haven’t setup direct deposit, or the information is no longer valid, the Treasury has developed a website that allows you to enter your direct deposit details for faster receipt.

I want to issue a word of warning about utilizing the Treasury’s websites. There are going to be a number of scammers and hackers taking advantage of this situation. Please, please, please be careful about what you’re doing with your personal information. Remember, the IRS will NEVER call or email and ask for your personal information. Also remember to check the website you’re using as it could be a fake site. We’ll post the correct site once it is made available.

What happens if I’m not eligible for the rebate based on my 2018 or 2019 tax return?

Since this is an advance on the recovery rebate, taxpayers who are ineligible based on their 2018 or 2019 income and who see a reduction in income in 2020, may receive the rebate as part of their 2020 return.

What happens if I receive a rebate that I wouldn’t qualify for based on my 2020 income?

While 2020 is expected to be a year of reduced incomes, some fortunate individuals may actually see their incomes rise. In this case, if those individuals receive an advance recovery rebate for 2019 that they wouldn’t otherwise qualify for based on 2020 income, then they’ll report that on their tax return. However, as of the passing of the bill, there is no claw back provision in the law that would suggest that the Treasury will recoup an overpayment. This means that even if an overpayment is calculated, you won’t have to “repay” it with your 2020 return.  Please note that this could be subject to change.

 

Looking for more information about the CARES Act?  Check out our blog post on Student Loan Forgiveness and the Expansion of Unemployment Under the CARES Act.