As the end of the year approaches, now is a good time to begin preparations for taxes. Of particular interest is understanding whether payments paid towards mortgage interest on the marital home are available as a mortgage interest deduction or if they are considered alimony (support) by the IRS come tax time. If the divorce or separation agreement requires one party to pay home mortgage interest on a home owned by both parties, the payment of interest may be alimony rather than mortgage interest.
While support payments are not the norm in Texas, support payments happen often enough for the divorcing and divorced and their advisers to understand the basics of tax implications associated with support payments. Not all payments under a divorce or separation agreement are considered support. Support does NOT include:
- Child support
- Non-Cash property settlements
- Payments that are your spouse’s part of community income
- Payment to keep up the payer’s property
- Use of the payer’s property
Interest or Alimony?
Let’s consider a few scenarios.
Scenario 1: Ownership of the property is transferred to wife, but husband pays
Under the separation agreement, the husband must pay the real estate taxes, mortgage payments, and insurance premiums on a home owned by the wife. If payments otherwise qualify, husband can deduct the payments as alimony on his return, and the wife must report them as alimony received. If itemizing deductions, wife can deduct the real estate taxes and, if the home is a qualified home, also include the interest on the mortgage in figuring deductible interest.
Scenario 2: Expenses paid by one party on a jointly owned home
If the divorce or separation agreement states that one spouse must pay expenses for a home that remains jointly owned by both parties, some of those payments may need to be classified as alimony paid and alimony received. There may be tax implications on how the mortgage interest deduction is classified regardless of how it is addressed within the divorce or separation agreement.
The below chart outlines how the mortgage payment, property taxes and insurance should be classified for tax reporting purposes.
Paying the mortgage directly vs. paying support may have advantages in terms of net benefit – as long as the tax implications are understood and assessed. Scenario planning can help optimize the total support amount received, which may benefit both parties. (Read more on this topic: Tax Implications of Paying Support vs. Paying the Mortgage and Net Support)
Attorneys for both of the divorcing spouses should take these tax implications into consideration when establishing the terms of the settlement agreement. By comparing different options, they are better able to derive the most beneficial outcome for their clients. A Certified Divorce Lending Professional (like me) can work with divorcing individuals and their attorneys to assess scenarios such as these during the divorce process.