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Amended Publication 523 - Introductory Material Table of Contents Future Developments Reminders IntroductionOrdering forms and publications. Amended Tax questions. Amended Useful Items - You may want to see: Future Developments For the latest information about developments related to Publication 523, such as legislation enacted after it was published, go to www. Amended irs. Amended gov/pub523. Amended Reminders Change of address. Amended If you change your mailing address, be sure to notify the Internal Revenue Service (IRS) using Form 8822, Change of Address. Amended Mail it to the Internal Revenue Service Center for your old address. Amended (Addresses for the Service Centers are on the back of the form. Amended ) Home sold with undeducted points. Amended If you have not deducted all the points you paid to secure a mortgage on your old home, you may be able to deduct the remaining points in the year of sale. Amended See Points in Publication 936, Home Mortgage Interest Deduction. Amended Photographs of missing children. Amended The Internal Revenue Service is a proud partner with the National Center for Missing and Exploited Children. Amended Photographs of missing children selected by the Center may appear in this publication on pages that would otherwise be blank. Amended You can help bring these children home by looking at the photographs and calling 1-800-THE-LOST (1-800-843-5678) if you recognize a child. Amended Introduction This publication explains the tax rules that apply when you sell your main home. Amended In most cases, your main home is the one in which you live most of the time. Amended If you sold your main home in 2013, you may be able to exclude from income any gain up to a limit of $250,000 ($500,000 on a joint return in most cases). Amended See Excluding the Gain , later. Amended Generally, if you can exclude all the gain, you do not need to report the sale on your tax return. Amended If you have gain that cannot be excluded, you generally must report it on Form 8949, Sales and Other Dispositions of Capital Assets, and Schedule D (Form 1040), Capital Gains and Losses. Amended You may also have to complete Form 4797, Sales of Business Property. Amended See Reporting the Sale , later. Amended If you have a loss on the sale, you generally cannot deduct it on your return. Amended However, you may need to report it. Amended See Reporting the Sale , later. Amended The main topics in this publication are: Figuring gain or loss, Basis, Excluding the gain, Ownership and use tests, and Reporting the sale. Amended Other topics include: Business use or rental of home, Deducting taxes in the year of sale, and Recapturing a federal mortgage subsidy. Amended Net Investment Income Tax (NIIT). Amended If any part of the gain on the sale of a home is not excluded under the rules discussed in this publication, it may be subject to the NIIT. Amended For more details, see Form 8960, Net Investment Income Tax—Individuals, Estates, and Trusts, and its instructions. Amended Worksheets. Amended Near the end of this publication you will find worksheets you can use to figure your gain (or loss) and your exclusion. Amended Use Worksheet 1 to figure the adjusted basis of the home you sold. Amended Use Worksheet 2 to figure the gain (or loss), the exclusion, and the taxable gain (if any) on the sale. Amended If you do not qualify for the maximum exclusion, use Worksheet 3 to figure your reduced maximum exclusion. Amended Date of sale. Amended If you received a Form 1099-S, Proceeds From Real Estate Transactions, the date of sale should be shown in box 1. Amended If you did not receive this form, the date of sale is the earlier of (a) the date title transferred or (b) the date the economic burdens and benefits of ownership shifted to the buyer. Amended In most cases, these dates are the same. Amended What is not covered in this publication. Amended This publication does not cover the sale of rental property, second homes, or vacation homes. Amended For information on how to report any gain or loss from those sales, see Publication 544, Sales and Other Dispositions of Assets. Amended Comments and suggestions. Amended We welcome your comments about this publication and your suggestions for future editions. Amended You can write to us at the following address: Internal Revenue Service Tax Forms and Publications Division 1111 Constitution Ave. Amended NW, IR-6526 Washington, DC 20224 We respond to many letters by telephone. Amended Therefore, it would be helpful if you would include your daytime phone number, including the area code, in your correspondence. Amended You can send your comments from www. Amended irs. Amended gov/formspubs/. Amended Click on “More Information” and then on “Comment on Tax Forms and Publications”. Amended Although we cannot respond individually to each comment received, we do appreciate your feedback and will consider your comments as we revise our tax products. Amended Ordering forms and publications. Amended Visit www. Amended irs. Amended gov/formspubs/ to download forms and publications, call 1-800-TAX-FORM (1-800-829-3676), or write to the address below and receive a response within 10 days after your request is received. Amended Internal Revenue Service 1201 N. Amended Mitsubishi Motorway Bloomington, IL 61705-6613 Tax questions. Amended If you have a tax question, check the information available on IRS. Amended gov or call 1-800-829-1040. Amended We cannot answer tax questions sent to either of the above addresses. Amended Useful Items - You may want to see: Publication 527 Residential Rental Property 530 Tax Information for Homeowners 544 Sales and Other Dispositions of Assets 547 Casualties, Disasters, and Thefts 551 Basis of Assets 587 Business Use of Your Home 936 Home Mortgage Interest Deduction 4681 Canceled Debts, Foreclosures, Repossessions, and Abandonments Form (and Instructions) Schedule A (Form 1040) Itemized Deductions Schedule D (Form 1040) Capital Gains and Losses 982 Reduction of Tax Attributes Due to Discharge of Indebtedness 1040 U. Amended S. Amended Individual Income Tax Return 1040NR U. Amended S. Amended Nonresident Alien Income Tax Return 1040X Amended U. Amended S. Amended Individual Income Tax Return 1099-S Proceeds From Real Estate Transactions 4797 Sales of Business Property 5405 Repayment of the First-Time Homebuyer Credit 8822 Change of Address 8828 Recapture of Federal Mortgage Subsidy 8939 Allocation of Increase in Basis for Property Acquired From a Decedent 8949 Sales and Other Dispositions of Capital Assets W-2 Wage and Tax Statement See How To Get Tax Help , near the end of this publication, for information about getting these publications and forms. Amended Prev Up Next Home More Online Publications
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Amended 4. Amended Interest Table of Contents Introduction Topics - This chapter discusses: Useful Items - You may want to see: Allocation of InterestOrder of funds spent. Amended Payments from checking accounts. Amended Amounts paid within 30 days. Amended Optional method for determining date of reallocation. Amended Interest on a segregated account. Amended How to report. Amended Interest You Can DeductStatement. Amended Expenses paid to obtain a mortgage. Amended Prepayment penalty. Amended De minimis OID. Amended Constant-yield method. Amended Loan or mortgage ends. Amended Interest You Cannot DeductPenalties. Amended Who is a key person? Exceptions for pre-June 1997 contracts. Amended Interest allocated to unborrowed policy cash value. Amended Capitalization of Interest When To Deduct InterestPrepaid interest. Amended Discounted loan. Amended Refunds of interest. Amended Prepaid interest. Amended Discounted loan. Amended Tax deficiency. Amended Related person. Amended Below-Market LoansLimit on forgone interest for gift loans of $100,000 or less. Amended Introduction This chapter discusses the tax treatment of business interest expense. Amended Business interest expense is an amount charged for the use of money you borrowed for business activities. Amended Topics - This chapter discusses: Allocation of interest Interest you can deduct Interest you cannot deduct Capitalization of interest When to deduct interest Below-market loans Useful Items - You may want to see: Publication 537 Installment Sales 550 Investment Income and Expenses 936 Home Mortgage Interest Deduction Form (and Instructions) Sch A (Form 1040) Itemized Deductions Sch E (Form 1040) Supplemental Income and Loss Sch K-1 (Form 1065) Partner's Share of Income, Deductions, Credits, etc. Amended Sch K-1 (Form 1120S) Shareholder's Share of Income, Deductions, Credits, etc. Amended 1098 Mortgage Interest Statement 3115 Application for Change in Accounting Method 4952 Investment Interest Expense Deduction 8582 Passive Activity Loss Limitations See chapter 12 for information about getting publications and forms. Amended Allocation of Interest The rules for deducting interest vary, depending on whether the loan proceeds are used for business, personal, or investment activities. Amended If you use the proceeds of a loan for more than one type of expense, you must allocate the interest based on the use of the loan's proceeds. Amended Allocate your interest expense to the following categories. Amended Nonpassive trade or business activity interest Passive trade or business activity interest Investment interest Portfolio interest Personal interest In general, you allocate interest on a loan the same way you allocate the loan proceeds. Amended You allocate loan proceeds by tracing disbursements to specific uses. Amended The easiest way to trace disbursements to specific uses is to keep the proceeds of a particular loan separate from any other funds. Amended Secured loan. Amended The allocation of loan proceeds and the related interest is not generally affected by the use of property that secures the loan. Amended Example. Amended You secure a loan with property used in your business. Amended You use the loan proceeds to buy an automobile for personal use. Amended You must allocate interest expense on the loan to personal use (purchase of the automobile) even though the loan is secured by business property. Amended If the property that secures the loan is your home, you generally do not allocate the loan proceeds or the related interest. Amended The interest is usually deductible as qualified home mortgage interest, regardless of how the loan proceeds are used. Amended For more information, see Publication 936. Amended Allocation period. Amended The period for which a loan is allocated to a particular use begins on the date the proceeds are used and ends on the earlier of the following dates. Amended The date the loan is repaid. Amended The date the loan is reallocated to another use. Amended Proceeds not disbursed to borrower. Amended Even if the lender disburses the loan proceeds to a third party, the allocation of the loan is still based on your use of the funds. Amended This applies whether you pay for property, services, or anything else by incurring a loan, or you take property subject to a debt. Amended Proceeds deposited in borrower's account. Amended Treat loan proceeds deposited in an account as property held for investment. Amended It does not matter whether the account pays interest. Amended Any interest you pay on the loan is investment interest expense. Amended If you withdraw the proceeds of the loan, you must reallocate the loan based on the use of the funds. Amended Example. Amended Celina, a calendar-year taxpayer, borrows $100,000 on January 4 and immediately uses the proceeds to open a checking account. Amended No other amounts are deposited in the account during the year and no part of the loan principal is repaid during the year. Amended On April 2, Celina uses $20,000 from the checking account for a passive activity expenditure. Amended On September 4, Celina uses an additional $40,000 from the account for personal purposes. Amended Under the interest allocation rules, the entire $100,000 loan is treated as property held for investment for the period from January 4 through April 1. Amended From April 2 through September 3, Celina must treat $20,000 of the loan as used in the passive activity and $80,000 of the loan as property held for investment. Amended From September 4 through December 31, she must treat $40,000 of the loan as used for personal purposes, $20,000 as used in the passive activity, and $40,000 as property held for investment. Amended Order of funds spent. Amended Generally, you treat loan proceeds deposited in an account as used (spent) before either of the following amounts. Amended Any unborrowed amounts held in the same account. Amended Any amounts deposited after these loan proceeds. Amended Example. Amended On January 9, Olena opened a checking account, depositing $500 of the proceeds of Loan A and $1,000 of unborrowed funds. Amended The following table shows the transactions in her account during the tax year. Amended Date Transaction January 9 $500 proceeds of Loan A and $1,000 unborrowed funds deposited January 14 $500 proceeds of Loan B deposited February 19 $800 used for personal purposes February 27 $700 used for passive activity June 19 $1,000 proceeds of Loan C deposited November 20 $800 used for an investment December 18 $600 used for personal purposes Olena treats the $800 used for personal purposes as made from the $500 proceeds of Loan A and $300 of the proceeds of Loan B. Amended She treats the $700 used for a passive activity as made from the remaining $200 proceeds of Loan B and $500 of unborrowed funds. Amended She treats the $800 used for an investment as made entirely from the proceeds of Loan C. Amended She treats the $600 used for personal purposes as made from the remaining $200 proceeds of Loan C and $400 of unborrowed funds. Amended For the periods during which loan proceeds are held in the account, Olena treats them as property held for investment. Amended Payments from checking accounts. Amended Generally, you treat a payment from a checking or similar account as made at the time the check is written if you mail or deliver it to the payee within a reasonable period after you write it. Amended You can treat checks written on the same day as written in any order. Amended Amounts paid within 30 days. Amended If you receive loan proceeds in cash or if the loan proceeds are deposited in an account, you can treat any payment (up to the amount of the proceeds) made from any account you own, or from cash, as made from those proceeds. Amended This applies to any payment made within 30 days before or after the proceeds are received in cash or deposited in your account. Amended If the loan proceeds are deposited in an account, you can apply this rule even if the rules stated earlier under Order of funds spent would otherwise require you to treat the proceeds as used for other purposes. Amended If you apply this rule to any payments, disregard those payments (and the proceeds from which they are made) when applying the rules stated under Order of funds spent. Amended If you received the loan proceeds in cash, you can treat the payment as made on the date you received the cash instead of the date you actually made the payment. Amended Example. Amended Giovanni gets a loan of $1,000 on August 4 and receives the proceeds in cash. Amended Giovanni deposits $1,500 in an account on August 18 and on August 28 writes a check on the account for a passive activity expense. Amended Also, Giovanni deposits his paycheck, deposits other loan proceeds, and pays his bills during the same period. Amended Regardless of these other transactions, Giovanni can treat $1,000 of the deposit he made on August 18 as being paid on August 4 from the loan proceeds. Amended In addition, Giovanni can treat the passive activity expense he paid on August 28 as made from the $1,000 loan proceeds treated as deposited in the account. Amended Optional method for determining date of reallocation. Amended You can use the following method to determine the date loan proceeds are reallocated to another use. Amended You can treat all payments from loan proceeds in the account during any month as taking place on the later of the following dates. Amended The first day of that month. Amended The date the loan proceeds are deposited in the account. Amended However, you can use this optional method only if you treat all payments from the account during the same calendar month in the same way. Amended Interest on a segregated account. Amended If you have an account that contains only loan proceeds and interest earned on the account, you can treat any payment from that account as being made first from the interest. Amended When the interest earned is used up, any remaining payments are from loan proceeds. Amended Example. Amended You borrowed $20,000 and used the proceeds of this loan to open a new savings account. Amended When the account had earned interest of $867, you withdrew $20,000 for personal purposes. Amended You can treat the withdrawal as coming first from the interest earned on the account, $867, and then from the loan proceeds, $19,133 ($20,000 − $867). Amended All the interest charged on the loan from the time it was deposited in the account until the time of the withdrawal is investment interest expense. Amended The interest charged on the part of the proceeds used for personal purposes ($19,133) from the time you withdrew it until you either repay it or reallocate it to another use is personal interest expense. Amended The interest charged on the loan proceeds you left in the account ($867) continues to be investment interest expense until you either repay it or reallocate it to another use. Amended Loan repayment. Amended When you repay any part of a loan allocated to more than one use, treat it as being repaid in the following order. Amended Personal use. Amended Investments and passive activities (other than those included in (3)). Amended Passive activities in connection with a rental real estate activity in which you actively participate. Amended Former passive activities. Amended Trade or business use and expenses for certain low-income housing projects. Amended Line of credit (continuous borrowings). Amended The following rules apply if you have a line of credit or similar arrangement. Amended Treat all borrowed funds on which interest accrues at the same fixed or variable rate as a single loan. Amended Treat borrowed funds or parts of borrowed funds on which interest accrues at different fixed or variable rates as different loans. Amended Treat these loans as repaid in the order shown on the loan agreement. Amended Loan refinancing. Amended Allocate the replacement loan to the same uses to which the repaid loan was allocated. Amended Make the allocation only to the extent you use the proceeds of the new loan to repay any part of the original loan. Amended Debt-financed distribution. Amended A debt-financed distribution occurs when a partnership or S corporation borrows funds and allocates those funds to distributions made to partners or shareholders. Amended The manner in which you report the interest expense associated with the distributed debt proceeds depends on your use of those proceeds. Amended How to report. Amended If the proceeds were used in a nonpassive trade or business activity, report the interest on Schedule E (Form 1040), line 28; enter “interest expense” and the name of the partnership or S corporation in column (a) and the amount in column (h). Amended If the proceeds were used in a passive activity, follow the Instructions for Form 8582, Passive Activity Loss Limitations, to determine the amount of interest expense that can be reported on Schedule E (Form 1040), line 28; enter “interest expense” and the name of the partnership in column (a) and the amount in column (f). Amended If the proceeds were used in an investment activity, enter the interest on Form 4952. Amended If the proceeds are used for personal purposes, the interest is generally not deductible. Amended Interest You Can Deduct You can generally deduct as a business expense all interest you pay or accrue during the tax year on debts related to your trade or business. Amended Interest relates to your trade or business if you use the proceeds of the loan for a trade or business expense. Amended It does not matter what type of property secures the loan. Amended You can deduct interest on a debt only if you meet all the following requirements. Amended You are legally liable for that debt. Amended Both you and the lender intend that the debt be repaid. Amended You and the lender have a true debtor-creditor relationship. Amended Partial liability. Amended If you are liable for part of a business debt, you can deduct only your share of the total interest paid or accrued. Amended Example. Amended You and your brother borrow money. Amended You are liable for 50% of the note. Amended You use your half of the loan in your business, and you make one-half of the loan payments. Amended You can deduct your half of the total interest payments as a business deduction. Amended Mortgage. Amended Generally, mortgage interest paid or accrued on real estate you own legally or equitably is deductible. Amended However, rather than deducting the interest currently, you may have to add it to the cost basis of the property as explained later under Capitalization of Interest. Amended Statement. Amended If you paid $600 or more of mortgage interest (including certain points) during the year on any one mortgage, you generally will receive a Form 1098 or a similar statement. Amended You will receive the statement if you pay interest to a person (including a financial institution or a cooperative housing corporation) in the course of that person's trade or business. Amended A governmental unit is a person for purposes of furnishing the statement. Amended If you receive a refund of interest you overpaid in an earlier year, this amount will be reported in box 3 of Form 1098. Amended You cannot deduct this amount. Amended For information on how to report this refund, see Refunds of interest, later in this chapter. Amended Expenses paid to obtain a mortgage. Amended Certain expenses you pay to obtain a mortgage cannot be deducted as interest. Amended These expenses, which include mortgage commissions, abstract fees, and recording fees, are capital expenses. Amended If the property mortgaged is business or income-producing property, you can amortize the costs over the life of the mortgage. Amended Prepayment penalty. Amended If you pay off your mortgage early and pay the lender a penalty for doing this, you can deduct the penalty as interest. Amended Interest on employment tax deficiency. Amended Interest charged on employment taxes assessed on your business is deductible. Amended Original issue discount (OID). Amended OID is a form of interest. Amended A loan (mortgage or other debt) generally has OID when its proceeds are less than its principal amount. Amended The OID is the difference between the stated redemption price at maturity and the issue price of the loan. Amended A loan's stated redemption price at maturity is the sum of all amounts (principal and interest) payable on it other than qualified stated interest. Amended Qualified stated interest is stated interest that is unconditionally payable in cash or property (other than another loan of the issuer) at least annually over the term of the loan at a single fixed rate. Amended You generally deduct OID over the term of the loan. Amended Figure the amount to deduct each year using the constant-yield method, unless the OID on the loan is de minimis. Amended De minimis OID. Amended The OID is de minimis if it is less than one-fourth of 1% (. Amended 0025) of the stated redemption price of the loan at maturity multiplied by the number of full years from the date of original issue to maturity (the term of the loan). Amended If the OID is de minimis, you can choose one of the following ways to figure the amount you can deduct each year. Amended On a constant-yield basis over the term of the loan. Amended On a straight-line basis over the term of the loan. Amended In proportion to stated interest payments. Amended In its entirety at maturity of the loan. Amended You make this choice by deducting the OID in a manner consistent with the method chosen on your timely filed tax return for the tax year in which the loan is issued. Amended Example. Amended On January 1, 2013, you took out a $100,000 discounted loan and received $98,500 in proceeds. Amended The loan will mature on January 1, 2023 (a 10-year term), and the $100,000 principal is payable on that date. Amended Interest of $10,000 is payable on January 1 of each year, beginning January 1, 2014. Amended The $1,500 OID on the loan is de minimis because it is less than $2,500 ($100,000 × . Amended 0025 × 10). Amended You choose to deduct the OID on a straight-line basis over the term of the loan. Amended Beginning in 2013, you can deduct $150 each year for 10 years. Amended Constant-yield method. Amended If the OID is not de minimis, you must use the constant-yield method to figure how much you can deduct each year. Amended You figure your deduction for the first year using the following steps. Amended Determine the issue price of the loan. Amended Generally, this equals the proceeds of the loan. Amended If you paid points on the loan (as discussed later), the issue price generally is the difference between the proceeds and the points. Amended Multiply the result in (1) by the yield to maturity. Amended Subtract any qualified stated interest payments from the result in (2). Amended This is the OID you can deduct in the first year. Amended To figure your deduction in any subsequent year, follow the above steps, except determine the adjusted issue price in step (1). Amended To get the adjusted issue price, add to the issue price any OID previously deducted. Amended Then follow steps (2) and (3) above. Amended The yield to maturity is generally shown in the literature you receive from your lender. Amended If you do not have this information, consult your lender or tax advisor. Amended In general, the yield to maturity is the discount rate that, when used in computing the present value of all principal and interest payments, produces an amount equal to the principal amount of the loan. Amended Example. Amended The facts are the same as in the previous example, except that you deduct the OID on a constant yield basis over the term of the loan. Amended The yield to maturity on your loan is 10. Amended 2467%, compounded annually. Amended For 2013, you can deduct $93 [($98,500 × . Amended 102467) − $10,000]. Amended For 2014, you can deduct $103 [($98,593 × . Amended 102467) − $10,000]. Amended Loan or mortgage ends. Amended If your loan or mortgage ends, you may be able to deduct any remaining OID in the tax year in which the loan or mortgage ends. Amended A loan or mortgage may end due to a refinancing, prepayment, foreclosure, or similar event. Amended If you refinance with the original lender, you generally cannot deduct the remaining OID in the year in which the refinancing occurs, but you may be able to deduct it over the term of the new mortgage or loan. Amended See Interest paid with funds borrowed from original lender under Interest You Cannot Deduct, later. Amended Points. Amended The term “points” is used to describe certain charges paid, or treated as paid, by a borrower to obtain a loan or a mortgage. Amended These charges are also called loan origination fees, maximum loan charges, discount points, or premium charges. Amended If any of these charges (points) are solely for the use of money, they are interest. Amended Because points are prepaid interest, you generally cannot deduct the full amount in the year paid. Amended However, you can choose to fully deduct points in the year paid if you meet certain tests. Amended For exceptions to the general rule, see Publication 936. Amended The points reduce the issue price of the loan and result in original issue discount (OID), deductible as explained in the preceding discussion. Amended Partial payments on a nontax debt. Amended If you make partial payments on a debt (other than a debt owed the IRS), the payments are applied, in general, first to interest and any remainder to principal. Amended You can deduct only the interest. Amended This rule does not apply when it can be inferred that the borrower and lender understood that a different allocation of the payments would be made. Amended Installment purchase. Amended If you make an installment purchase of business property, the contract between you and the seller generally provides for the payment of interest. Amended If no interest or a low rate of interest is charged under the contract, a portion of the stated principal amount payable under the contract may be recharacterized as interest (unstated interest). Amended The amount recharacterized as interest reduces your basis in the property and increases your interest expense. Amended For more information on installment sales and unstated interest, see Publication 537. Amended Interest You Cannot Deduct Certain interest payments cannot be deducted. Amended In addition, certain other expenses that may seem to be interest but are not, cannot be deducted as interest. Amended You cannot currently deduct interest that must be capitalized, and you generally cannot deduct personal interest. Amended Interest paid with funds borrowed from original lender. Amended If you use the cash method of accounting, you cannot deduct interest you pay with funds borrowed from the original lender through a second loan, an advance, or any other arrangement similar to a loan. Amended You can deduct the interest expense once you start making payments on the new loan. Amended When you make a payment on the new loan, you first apply the payment to interest and then to the principal. Amended All amounts you apply to the interest on the first loan are deductible, along with any interest you pay on the second loan, subject to any limits that apply. Amended Capitalized interest. Amended You cannot currently deduct interest you are required to capitalize under the uniform capitalization rules. Amended See Capitalization of Interest, later. Amended In addition, if you buy property and pay interest owed by the seller (for example, by assuming the debt and any interest accrued on the property), you cannot deduct the interest. Amended Add this interest to the basis of the property. Amended Commitment fees or standby charges. Amended Fees you incur to have business funds available on a standby basis, but not for the actual use of the funds, are not deductible as interest payments. Amended You may be able to deduct them as business expenses. Amended If the funds are for inventory or certain property used in your business, the fees are indirect costs and you generally must capitalize them under the uniform capitalization rules. Amended See Capitalization of Interest, later. Amended Interest on income tax. Amended Interest charged on income tax assessed on your individual income tax return is not a business deduction even though the tax due is related to income from your trade or business. Amended Treat this interest as a business deduction only in figuring a net operating loss deduction. Amended Penalties. Amended Penalties on underpaid deficiencies and underpaid estimated tax are not interest. Amended You cannot deduct them. Amended Generally, you cannot deduct any fines or penalties. Amended Interest on loans with respect to life insurance policies. Amended You generally cannot deduct interest on a debt incurred with respect to any life insurance, annuity, or endowment contract that covers any individual unless that individual is a key person. Amended If the policy or contract covers a key person, you can deduct the interest on up to $50,000 of debt for that person. Amended However, the deduction for any month cannot be more than the interest figured using Moody's Composite Yield on Seasoned Corporate Bonds (formerly known as Moody's Corporate Bond Yield Average-Monthly Average Corporates) (Moody's rate) for that month. Amended Who is a key person? A key person is an officer or 20% owner. Amended However, the number of individuals you can treat as key persons is limited to the greater of the following. Amended Five individuals. Amended The lesser of 5% of the total officers and employees of the company or 20 individuals. Amended Exceptions for pre-June 1997 contracts. Amended You can generally deduct the interest if the contract was issued before June 9, 1997, and the covered individual is someone other than an employee, officer, or someone financially interested in your business. Amended If the contract was purchased before June 21, 1986, you can generally deduct the interest no matter who is covered by the contract. Amended Interest allocated to unborrowed policy cash value. Amended Corporations and partnerships generally cannot deduct any interest expense allocable to unborrowed cash values of life insurance, annuity, or endowment contracts. Amended This rule applies to contracts issued after June 8, 1997, that cover someone other than an officer, director, employee, or 20% owner. Amended For more information, see section 264(f) of the Internal Revenue Code. Amended Capitalization of Interest Under the uniform capitalization rules, you generally must capitalize interest on debt equal to your expenditures to produce real property or certain tangible personal property. Amended The property must be produced by you for use in your trade or business or for sale to customers. Amended You cannot capitalize interest related to property that you acquire in any other manner. Amended Interest you paid or incurred during the production period must be capitalized if the property produced is designated property. Amended Designated property is any of the following. Amended Real property. Amended Tangible personal property with a class life of 20 years or more. Amended Tangible personal property with an estimated production period of more than 2 years. Amended Tangible personal property with an estimated production period of more than 1 year if the estimated cost of production is more than $1 million. Amended Property you produce. Amended You produce property if you construct, build, install, manufacture, develop, improve, create, raise, or grow it. Amended Treat property produced for you under a contract as produced by you up to the amount you pay or incur for the property. Amended Carrying charges. Amended Carrying charges include taxes you pay to carry or develop real estate or to carry, transport, or install personal property. Amended You can choose to capitalize carrying charges not subject to the uniform capitalization rules if they are otherwise deductible. Amended For more information, see chapter 7. Amended Capitalized interest. Amended Treat capitalized interest as a cost of the property produced. Amended You recover your interest when you sell or use the property. Amended If the property is inventory, recover capitalized interest through cost of goods sold. Amended If the property is used in your trade or business, recover capitalized interest through an adjustment to basis, depreciation, amortization, or other method. Amended Partnerships and S corporations. Amended The interest capitalization rules are applied first at the partnership or S corporation level. Amended The rules are then applied at the partners' or shareholders' level to the extent the partnership or S corporation has insufficient debt to support the production or construction costs. Amended If you are a partner or a shareholder, you may have to capitalize interest you incur during the tax year for the production costs of the partnership or S corporation. Amended You may also have to capitalize interest incurred by the partnership or S corporation for your own production costs. Amended To properly capitalize interest under these rules, you must be given the required information in an attachment to the Schedule K-1 you receive from the partnership or S corporation. Amended Additional information. Amended The procedures for applying the uniform capitalization rules are beyond the scope of this publication. Amended For more information, see sections 1. Amended 263A-8 through 1. Amended 263A-15 of the regulations and Notice 88-99. Amended Notice 88-99 is in Cumulative Bulletin 1988-2. Amended When To Deduct Interest If the uniform capitalization rules, discussed under Capitalization of Interest, earlier, do not apply to you, deduct interest as follows. Amended Cash method. Amended Under the cash method, you can generally deduct only the interest you actually paid during the tax year. Amended You cannot deduct a promissory note you gave as payment because it is a promise to pay and not an actual payment. Amended Prepaid interest. Amended You generally cannot deduct any interest paid before the year it is due. Amended Interest paid in advance can be deducted only in the tax year in which it is due. Amended Discounted loan. Amended If interest or a discount is subtracted from your loan proceeds, it is not a payment of interest and you cannot deduct it when you get the loan. Amended For more information, see Original issue discount (OID) under Interest You Can Deduct, earlier. Amended Refunds of interest. Amended If you pay interest and then receive a refund in the same tax year of any part of the interest, reduce your interest deduction by the refund. Amended If you receive the refund in a later tax year, include the refund in your income to the extent the deduction for the interest reduced your tax. Amended Accrual method. Amended Under an accrual method, you can deduct only interest that has accrued during the tax year. Amended Prepaid interest. Amended See Prepaid interest, earlier. Amended Discounted loan. Amended See Discounted loan, earlier. Amended Tax deficiency. Amended If you contest a federal income tax deficiency, interest does not accrue until the tax year the final determination of liability is made. Amended If you do not contest the deficiency, then the interest accrues in the year the tax was asserted and agreed to by you. Amended However, if you contest but pay the proposed tax deficiency and interest, and you do not designate the payment as a cash bond, then the interest is deductible in the year paid. Amended Related person. Amended If you use an accrual method, you cannot deduct interest owed to a related person who uses the cash method until payment is made and the interest is includible in the gross income of that person. Amended The relationship is determined as of the end of the tax year for which the interest would otherwise be deductible. Amended See section 267 of the Internal Revenue Code for more information. Amended Below-Market Loans If you receive a below-market gift or demand loan and use the proceeds in your trade or business, you may be able to deduct the forgone interest. Amended See Treatment of gift and demand loans, later, in this discussion. Amended A below-market loan is a loan on which no interest is charged or on which interest is charged at a rate below the applicable federal rate. Amended A gift or demand loan that is a below-market loan generally is considered an arm's-length transaction in which you, the borrower, are considered as having received both the following. Amended A loan in exchange for a note that requires the payment of interest at the applicable federal rate. Amended An additional payment in an amount equal to the forgone interest. Amended The additional payment is treated as a gift, dividend, contribution to capital, payment of compensation, or other payment, depending on the substance of the transaction. Amended Forgone interest. Amended For any period, forgone interest is The interest that would be payable for that period if interest accrued on the loan at the applicable federal rate and was payable annually on December 31, minus Any interest actually payable on the loan for the period. Amended Applicable federal rates are published by the IRS each month in the Internal Revenue Bulletin. Amended Internal Revenue Bulletins are available on the IRS web site at www. Amended irs. Amended gov/irb. Amended You can also contact an IRS office to get these rates. Amended Loans subject to the rules. Amended The rules for below-market loans apply to the following. Amended Gift loans (below-market loans where the forgone interest is in the nature of a gift). Amended Compensation-related loans (below-market loans between an employer and an employee or between an independent contractor and a person for whom the contractor provides services). Amended Corporation-shareholder loans. Amended Tax avoidance loans (below-market loans where the avoidance of federal tax is one of the main purposes of the interest arrangement). Amended Loans to qualified continuing care facilities under a continuing care contract (made after October 11, 1985). Amended Except as noted in (5) above, these rules apply to demand loans (loans payable in full at any time upon the lender's demand) outstanding after June 6, 1984, and to term loans (loans that are not demand loans) made after that date. Amended Treatment of gift and demand loans. Amended If you receive a below-market gift loan or demand loan, you are treated as receiving an additional payment (as a gift, dividend, etc. Amended ) equal to the forgone interest on the loan. Amended You are then treated as transferring this amount back to the lender as interest. Amended These transfers are considered to occur annually, generally on December 31. Amended If you use the loan proceeds in your trade or business, you can deduct the forgone interest each year as a business interest expense. Amended The lender must report it as interest income. Amended Limit on forgone interest for gift loans of $100,000 or less. Amended For gift loans between individuals, forgone interest treated as transferred back to the lender is limited to the borrower's net investment income for the year. Amended This limit applies if the outstanding loans between the lender and borrower total $100,000 or less. Amended If the borrower's net investment income is $1,000 or less, it is treated as zero. Amended This limit does not apply to a loan if the avoidance of any federal tax is one of the main purposes of the interest arrangement. Amended Treatment of term loans. Amended If you receive a below-market term loan other than a gift or demand loan, you are treated as receiving an additional cash payment (as a dividend, etc. Amended ) on the date the loan is made. Amended This payment is equal to the loan amount minus the present value, at the applicable federal rate, of all payments due under the loan. Amended The same amount is treated as original issue discount on the loan. Amended See Original issue discount (OID) under Interest You Can Deduct, earlier. Amended Exceptions for loans of $10,000 or less. Amended The rules for below-market loans do not apply to any day on which the total outstanding loans between the borrower and lender is $10,000 or less. Amended This exception applies only to the following. Amended Gift loans between individuals if the loan is not directly used to buy or carry income-producing assets. Amended Compensation-related loans or corporation-shareholder loans if the avoidance of any federal tax is not a principal purpose of the interest arrangement. Amended This exception does not apply to a term loan described in (2) above that was previously subject to the below-market loan rules. Amended Those rules will continue to apply even if the outstanding balance is reduced to $10,000 or less. Amended Exceptions for loans without significant tax effect. Amended The following loans are specifically exempted from the rules for below-market loans because their interest arrangements do not have a significant effect on the federal tax liability of the borrower or the lender. Amended Loans made available by lenders to the general public on the same terms and conditions that are consistent with the lender's customary business practices. Amended Loans subsidized by a federal, state, or municipal government that are made available under a program of general application to the public. Amended Certain employee-relocation loans. Amended Certain loans to or from a foreign person, unless the interest income would be effectively connected with the conduct of a U. Amended S. Amended trade or business and not exempt from U. Amended S. Amended tax under an income tax treaty. Amended Any other loan if the taxpayer can show that the interest arrangement has no significant effect on the federal tax liability of the lender or the borrower. Amended Whether an interest arrangement has a significant effect on the federal tax liability of the lender or the borrower will be determined by all the facts and circumstances. Amended Consider all the following factors. Amended Whether items of income and deduction generated by the loan offset each other. Amended The amount of the items. Amended The cost of complying with the below-market loan provisions if they were to apply. Amended Any reasons, other than taxes, for structuring the transaction as a below-market loan. Amended Exception for loans to qualified continuing care facilities. Amended The below-market interest rules do not apply to a loan owed by a qualified continuing care facility under a continuing care contract if the lender or lender's spouse is age 62 or older by the end of the calendar year. Amended A qualified continuing care facility is one or more facilities (excluding nursing homes) meeting the requirements listed below. Amended Designed to provide services under continuing care contracts (defined below). Amended Includes an independent living unit, and either an assisted living or nursing facility, or both. Amended Substantially all of the independent living unit residents are covered by continuing care contracts. Amended A continuing care contract is a written contract between an individual and a qualified continuing care facility that includes all of the following conditions. Amended The individual or individual's spouse must be entitled to use the facility for the rest of their life or lives. Amended The individual or individual's spouse will be provided with housing, as appropriate for the health of the individual or individual's spouse in an: independent living unit (which has additional available facilities outside the unit for the provision of meals and other personal care), and assisted living or nursing facility available in the continuing care facility. Amended The individual or individual's spouse will be provided with assisted living or nursing care available in the continuing care facility, as required for the health of the individual or the individual's spouse. Amended For more information, see section 7872(h) of the Internal Revenue Code. Amended Sale or exchange of property. Amended Different rules generally apply to a loan connected with the sale or exchange of property. Amended If the loan does not provide adequate stated interest, part of the principal payment may be considered interest. Amended However, there are exceptions that may require you to apply the below-market interest rate rules to these loans. Amended See Unstated Interest and Original Issue Discount (OID) in Publication 537. Amended More information. Amended For more information on below-market loans, see section 7872 of the Internal Revenue Code and section 1. Amended 7872-5 of the regulations. Amended Prev Up Next Home More Online Publications