As a homeowner, you're probably aware that you can deduct a healthy portion of the interest that you pay on your mortgage from your total taxable income. In order to claim this deduction, you can't fall in one of the top two tax brackets and must file your taxes as either a "single" or "married" filer. You can't choose the "married filing separately" option that many taxpayers utilize to save money on certain business expenses. You must also refrain from deducting any of the principal that you paid on your mortgage. If you fail to adhere to any of these basic requirements, you may be at risk for an IRS audit.
There are some circumstances in which you may be able to deduct the interest on your parents' mortgage from your own taxable income. If you pay the mortgage on your parents' house, you can't simply claim the applicable interest payments as a deduction. The IRS assumes that any funds used in this manner are intended for use as "gifts." Unfortunately, gifts are neither taxable nor tax-deductible under current federal law. In other words, your parents won't be liable for paying taxes on the mortgage payments that you make on their behalf. However, you won't be able to claim these payments as tax-deductible expenses.
This general rule contains several key loopholes. If you can define your parents' house as your "second home," you may be able to deduct the interest that you pay on its mortgage from your taxable income. You'll need to ensure that the deed to the house is in your name before attempting to make this deduction. If your parents compensate you for the time that they spend in "their" house, you'll also need to spend at least 36 nights per year at the house. This is because the IRS requires homeowners who rent out their second homes to use them as their primary residences for at least part of the year. Otherwise, such a maneuver would constitute an abuse of the federal laws that govern rental properties.
If your parents live in the house on a rent-free basis, you're not required to spend any time there. For the IRS's purposes, the house might as well be sitting vacant. It's important to note that you can't deduct any mortgage interest on a mortgage that's worth more than the house that secures it. In most cases, you'll need to provide the IRS with two Form 1098s as proof of your mortgage debts.