Inherited Mortgage

[Red Corvette]

I have inherited a 25% share in a mortgage that my mother and her business partner financed when they sold a rental house they owned. I will receive 25% payments from the homeowner.
I assume I must pay tax on both interest and principal paid to me. Do I need to separate the interest and principal portions of the payments and keep track of them in order to pay the taxes? Would the principal be considered ordinary income?

 

[jebmke]

I have inherited a 25% share in a mortgage that my mother and her business partner financed when they sold a rental house they owned. I will receive 25% payments from the homeowner.
I assume I must pay tax on both interest and principal paid to me. Do I need to separate the interest and principal portions of the payments and keep track of them in order to pay the taxes? Would the principal be considered ordinary income?

I'm no expert but I think the principal is treated the same as if you inherited money (no income tax) and you would report the interest only on Schedule B.

However, having thought further, an alternative view might be that the entire mortgage gets revalued at time of death to fair market value and then a recalculation would have to be done to split out the principal and interest over the remaining life of the mortgage. I'd have to look at how assets are treated if the reval is a markdown rather than a step up. If it is a step up, the calculation would not be difficult.

 

[Souschef]

IMO, The value of the mortgage is fixed by the documents establishing the mortgage.
If it is an interest only mortgage, all that interest is taxable. If the payments are principal and interest, only the interest is taxable. The principal is tax free.
There are amortization tables on line to calculate how much is principal and how mush is interest.

 

[pb4uski]

Yeah, I would report the interest as income but the principal is tax-free. There should be an amortization schedule in your mother's tax files or perhaps her business partner can provide one.

I wouldn't bother with stepped-up basis for the mortgage unless the interest rate on the mortgage is significantly different from the current rate for a similar credit and remaining term.