Probate & Trust Law Section Conference Manual ... - Minnesota CLE

III. DEDUCTION OF MORTGAGE INTEREST BY ESTATES & TRUSTS.
A. Qualified Residence Interest. IRS Code §163 provides that:
•Personal interest is not deductible by non-corporate taxpayers. See §163(h).
•Qualified Residence Interest is deductible if it is paid on acquisition indebtedness
or home equity debt secured by the taxpayer’s principal home or a second home.
See §163(h)(3).
•For estates or trusts, the mortgage interest is only deductible if the home
continues to be the principal residence or a second residence of a person who is
either a current beneficiary or a beneficiary of the residue of the estate or trust.
See §163(h)(4)(D), RIA -5474.1.
B. Investment Interest. Interest expense may be deductible as investment interest
expense if the money was borrowed to purchase investment property (i.e., assets that
generate interest, dividends, annuity or royalty income) but the investment interest
deduction is limited to the amount of investment income earned (i.e, net interest, nonqualified
dividends, annuity or royalty income). See Form 4952 and instructions for
more details.
C. Rental or Business Interest. If the interest expense relates to property that is used as
rental property or is used in a trade or business, the interest is deductible within the rules
for those activities.
D. Estate Tax Deduction. Interest expense accrued prior to the date of death but paid
after the date of death can be deducted as a debt of the decedent for estate tax purposes.
See Form 706, Schedule K.
E. No Income Tax Deduction By Estate. Unless one of the rules above is met, mortgage
interest expense that is accrued and paid after the death (even otherwise deductible
mortgage interest expense) is classified as personal interest and is not deductible as an
estate administration expense on either Form 1041 or Form 706.
IV. DEDUCTION OF OTHER POST-DEATH EXPENSES.
A. General Rule: the decedent’s final income tax return (Form 1040) shows all income
received prior to death (cash based, not accrual) and deductible expenses actually paid
prior to death.
B. Decedent’s Final Form 1040. Some post-death items can be retroactively included on
the decedent’s final Form 1040:
•Medical expenses (pre-death) if paid within one year of death;
•Accrued but unpaid interest on U.S. Savings bonds (Rev. Rul. 68-145) can be
accelerated onto decedent’s final income tax return;
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