Can I Deduct Interest on a Personal Loan to Buy a House?

Full Question:

Iam loaning my son money to purchase a town house. How do I make this a legal loan and for the IRS to allow any interest he pays to me?
05/12/2010   |   Category: Taxes   |   State: Florida   |   #22091

Answer:

A promissory note may be secured or unsecured. When it is secured, it means that property, called collateral, may be taken by the lender if the borrower fails to pay the loan payment. If the debtor files bankruptcy, the lender may be able to recover the value of the loan by taking possession of the specified collateral instead of receiving only a portion of the borrower's property after it is divided among all creditors. Collateral may be many different types of property, such as personal property, shares of stock of a company, inventory, accounts receivable, etc.

The parties to the loan must sign it and the notary must witness the signatures. The contract may contain a choice of law clause as to where it will be litigated if a dispute arises. Choice of law refers to what jurisdiction's law is to be applied when there is a dispute in a transaction. The loan document may then be recorded in the county recorder's office where the property is located.

A promissory note may provide for payments to be made in installments or in a lump sum. The terms may provide for a series of smaller payments at the beginning of the loan period and a larger balloon payment at the end of the loan period. The option for a confessed judgment agreement, also called a cognovit note, may also be included. A confessed judgment agreement requires the debtor not to claim defenses and agree to have a judgment entered against him if he fails to pay and the matter is taken to court.

Promissory Note: A promissory note is a written promise to pay a debt and is typically signed at the time of the loan. It is an unconditional promise to pay on demand or at a fixed or determined future time a particular sum of money to or to the order of a specified person or to the bearer.

Cognovit Note: A cognovit note is a note in which the maker acknowledges the debt and authorizes the entry of judgment against him or her without notice or a hearing : a note containing a confession of judgment. This type of note is not valid in many States.

Collateral Note: A collateral note is a note secured by collateral. Same as a secured note.

Demand Note: A demand note is a note payable on demand from the person who is owed the money.

Floating Note: A floating rate note (or adjustable rate note) is a note where interest varies.

Recourse Note: A recourse note is a note where the default may result in loss of collateral and also personal suit and judgment. Most notes are recourse notes.

Renewal Note: A renewal note is a note that renews a previous note due date.

Unsecured Note: An unsecured note is a note that is not secured by any collateral but only the promise to pay (i.e. signature only is required to loan the money).

The IRS has specific requirements applicable to deducting interest on a loan to purchase property. Please see the following information on interest deductions to determine applicability:

http://www.irs.gov/taxtopics/tc505.html
http://www.irs.gov/publications/p936/index.html