Question

Real Estate - Interest on Construction Loan paid by Builder - I reimburse prior to possess

Forum|Forum|1 year ago
May 28, 2024
2 replies
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Builder wanted me to do a construction to perm loan and I said no. This is a spec home he has built many times in a subdivision, so not a custom home. He wants me to reimburse him for the interest he will pay on the construction loan. He wrote it as a change order (Financing) - Payable prior to possession - financing costs payable to builder. My question is, do I need him to supply me with a 1098 to make this tax deductible to me on my taxes next year when I pay him and take possession of the home? He is financing with a local bank and he will get a 1098. I am not sure if the amount he is asking me to pay will even match the 1098, but that will be in his name anyways. Hoping someone can help answer how I need to handle this. If I pay for the financing cost, he shouldn’t get to deduct it.

Not A Product Question

rjs

Employee

Just my opinion, with no special expertise:

You didn't take out a loan, and you are not paying any interest, so you have no deduction for interest. The change order just increases the total price that you pay for the home. The additional amount is included in your cost basis. The fact that the builder intends it to cover his financing cost is irrelevant.

The builder cannot give you a 1098 because he did not make a loan to you and you are not paying interest to him.

There is nothing for you to report on your tax return for the year that you purchase the home.

Other people may have different opinions.

O

Opus 17

Employee

Whatever you pay him is the price for the house, it doesn't matter how he calculates it. It's not tax deductible to you because it is not a mortgage in your name that you are obligated to pay. Whatever you pay for the house is your cost basis, and paying a higher cost will reduce your taxable capital gains when you sell. But this is not a tax deduction for you.

And he does get to deduct it as business expense, because he is paying for it.

Think about a new car. The sticker price is $35,000 and the dealer will sell it to you for $33,000. What you don't know, because it happens behind the curtain, is that the dealer paid the factory $30,000 for the car, but the dealer borrowed the money and is paying $300 per month interest to the bank until they sell the car. That's why dealers are often ready to make a deal at the end of the month (before the next interest payment) and why they often make better deals on cars that have been sitting on the lot a long time (because the interest is adding up). But you don't pay $30,000 for the car plus $900 for interest plus $2100 dealer profit, you just pay $33,000 and that's your cost.

So with your house, you are buying a house for an agreed price. It makes no difference to you how much the builder paid for wood, cement, nails, shingles, pipes, wires, or labor. It also makes no difference to you how much money the builder borrowed or what his interest rate was. Normally, you never even see those details, you just agree on a price. Here, the builder seems to have found a tactic to persuade you to pay a higher price. But it doesn't matter what the tactic was, all that matters is that you will pay some agreed on final price for the house and that is your price. You are not the loan borrower, and you are not the owner of the property at the time the interest is being paid, so this is not a deductible expense for you. It's just part of the overall price of the house and it doesn't matter how that price was added up.

H

hamulcahyAuthor

Thanks for your input. He has written a separate change order saying that I am paying him outside the purchase price of the house for reimbursing him for the interest he is paying for the construction loan. I thought since it is separate and he has written it as such, that it would be deductible to me. I keep getting conflicting information. I already asked a real estate tax accountant who said the way it was written and not included in purchase price as clearly states it is for interest on construction loan it was deductible. Now I am not sure what to believe.

rjs

Employee

The builder can't change the tax laws. As a general rule, it doesn't matter what he calls it. What matters is the actual substance of the transaction.

I suggest that you consult a tax lawyer (not accountant). If the lawyer says you can deduct it as mortgage interest, ask for a written opinion so that you have solid backup if the IRS questions it. And keep in mind that if you deduct it now, you cannot include it in your basis. It's one or the other.