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Compare tax software Index Symbols 403(b) plans, 403(b) Plans A Accounting methods, Nonaccrual-Experience Method Acquisition date: Special depreciation allowance, Acquisition date test. Compare tax software Special Liberty Zone depreciation allowance, Acquisition date test. Compare tax software Annuities, tax-sheltered 403(b) plans, 403(b) Plans Assistance (see Tax help) Automobile (see Passenger automobile) B Bonds: New York Liberty, Tax Incentives for New York Liberty Zone Qualified zone academy, Issuance of Qualified Zone Academy Bonds C Car (see Passenger automobile) Car expenses, Car Expenses Catch-up contributions, 403(b), 403(b) Plans Child and dependent care, Child and Dependent Care Expenses Church employees and ministers, Years of service for church employees and ministers. Compare tax software Clean-fuel vehicle, Electric and Clean-Fuel Vehicles Comments, Comments and suggestions. Compare tax software Credit: Child and dependent care, Child and Dependent Care Expenses Credit for pension plan startup, Credit For Pension Plan Startup Costs Electric vehicles, Electric and Clean-Fuel Vehicles Indian employment, Indian Employment Credit Extended Renewable electricity production, Renewable Electricity Production Credit Welfare-to-work, Welfare-to-Work Credit Extended Work opportunity, Work Opportunity Credit Expanded in New York Liberty Zone , Work Opportunity Credit Extended D Deduction limit, automobile, Passenger Automobiles Deemed IRAs, Deemed IRAs Depletion, Depletion Depreciation: New property, Special Depreciation Allowance Property on reservations, Depreciation of Property Used on Indian Reservations Special depreciation allowance, Special Depreciation Allowance Special Liberty Zone depreciation allowance, Special Liberty Zone Depreciation Allowance Supplement to Publication 946, Depreciation E Election: Deemed not to claim special allowance, Deemed election. Compare tax software Not to claim special allowance, Election Not To Claim the Allowance Not to claim special Liberty Zone allowance, Election Not To Claim the Liberty Zone Allowance Electric vehicle, Electric and Clean-Fuel Vehicles Eligible educator, Deduction for Educator Expenses Estimated tax payments, Adjusting your withholding or estimated tax payments for 2002. Compare tax software Excepted property: Special depreciation allowance, Excepted Property Special Liberty Zone depreciation allowance, Excepted property. Compare tax software F Foreign missionaries, Foreign missionaries. Compare tax software Form 1099, Electronic Form 1099 Free tax services, How To Get Tax Help H Help (see Tax help) I Indian employment credit, Indian Employment Credit Extended Indian reservations, depreciation rules, Depreciation of Property Used on Indian Reservations IRAs, Deemed IRAs L Leasehold improvement property, defined, Qualified leasehold improvement property. Compare tax software Liberty Zone leasehold improvement property: Defined, Qualified New York Liberty Zone leasehold improvement property. Compare tax software Depreciated as 5-year property, Liberty Zone Leasehold Improvement Property Returns filed before June 1, 2002, Returns Filed Before June 1, 2002 Liberty Zone property: Increased section 179 dollar limit, Increased Dollar Limit Reduced section 179 dollar limit, Reduced Dollar Limit M Marginal production, Depletion More information (see Tax help) N Net operating losses, New 5-Year Carryback Rule for Net Operating Losses (NOLs), New 5-Year Carryback Rule for Net Operating Losses (NOLs) New York Liberty Zone: Area defined, New York Liberty Zone Benefits Leasehold improvement property, Liberty Zone Leasehold Improvement Property Section 179 deduction, Increased Section 179 Deduction Special depreciation, Special Liberty Zone Depreciation Allowance Tax incentives, Tax Incentives for New York Liberty Zone Work opportunity credit, Work Opportunity Credit Expanded in New York Liberty Zone NOLs, New 5-Year Carryback Rule for Net Operating Losses (NOLs), New 5-Year Carryback Rule for Net Operating Losses (NOLs) Nonaccrual-experience method, Nonaccrual-Experience Method Nonresidential real property, Nonresidential real property and residential rental property. Compare tax software P Passenger automobile, limit on, Passenger Automobiles Pension plan startup costs, Credit For Pension Plan Startup Costs Placed in service date, Placed in service date test. Compare tax software , Placed in service date test. Compare tax software Plans, tax-sheltered annuities, 403(b) plans, 403(b) Plans Publications (see Tax help) Q Qualified leasehold improvement property, defined, Qualified leasehold improvement property. Compare tax software Qualified Liberty Zone leasehold improvement property, Qualified New York Liberty Zone leasehold improvement property. Compare tax software Qualified property: Increased section 179 deduction, Qualified property. Compare tax software Special depreciation allowance, Qualified Property Special Liberty Zone depreciation allowance, Qualified Liberty Zone Property Qualified zone academy bonds, Issuance of Qualified Zone Academy Bonds R Recapture, section 179 deduction, Recapture Rules Renewable electricity, Renewable Electricity Production Credit Residential rental property, Nonresidential real property and residential rental property. Compare tax software Rollovers, 403(b) plans, Rollovers to and from 403(b) plans. Compare tax software S Section 1256 contracts, Wash Sale Rules Do Not Apply to Section 1256 Contracts Section 179 deduction: Increased dollar limit for Liberty Zone property, Increased Dollar Limit Reduced dollar limit for Liberty Zone property, Reduced Dollar Limit Returns filed before June 1, 2002, Returns Filed Before June 1, 2002 Simplified employee pensions (SEPs), Simplified Employee Pensions (SEPs) Special depreciation allowance: Election not to claim, Election Not To Claim the Allowance Excepted property, Excepted Property Qualified property, Qualified Property Requirements for claiming, Qualified Property Returns filed before June 1, 2002, Rules for Returns Filed Before June 1, 2002 Tests for qualification, Tests To Be Met Special Liberty Zone depreciation allowance: Election not to claim, Election Not To Claim the Liberty Zone Allowance Excepted property, Excepted property. Compare tax software Qualified property, Qualified Liberty Zone Property Requirements for claiming, Qualified Liberty Zone Property Returns filed before June 1, 2002, Returns filed before June 1, 2002. Compare tax software Tests for qualification, Tests to be met. Compare tax software Substantial use, special Liberty Zone depreciation allowance, Substantial use test. Compare tax software Suggestions, Comments and suggestions. Compare tax software T Tax help, How To Get Tax Help Tax-sheltered annuity plans, 403(b) plans, 403(b) Plans Taxpayer Advocate, Contacting your Taxpayer Advocate. Compare tax software Teachers, classroom materials, Deduction for Educator Expenses Tests for qualification, Tests To Be Met, Tests to be met. Compare tax software TTY/TDD information, How To Get Tax Help W Wash sale rules, Wash Sale Rules Do Not Apply to Section 1256 Contracts Welfare-to-work credit, Welfare-to-Work Credit Extended Withholding, Adjusting your withholding or estimated tax payments for 2002. Compare tax software Work opportunity credit, Work Opportunity Credit Expanded in New York Liberty Zone , Work Opportunity Credit Extended Y Years of service, church employees and ministers, Years of service for church employees and ministers. Compare tax software Prev  Up     Home   More Online Publications
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Compare tax software 4. Compare tax software   Interest Table of Contents Introduction Topics - This chapter discusses: Useful Items - You may want to see: Allocation of InterestOrder of funds spent. Compare tax software Payments from checking accounts. Compare tax software Amounts paid within 30 days. Compare tax software Optional method for determining date of reallocation. Compare tax software Interest on a segregated account. Compare tax software How to report. Compare tax software Interest You Can DeductStatement. Compare tax software Expenses paid to obtain a mortgage. Compare tax software Prepayment penalty. Compare tax software De minimis OID. Compare tax software Constant-yield method. Compare tax software Loan or mortgage ends. Compare tax software Interest You Cannot DeductPenalties. Compare tax software Who is a key person? Exceptions for pre-June 1997 contracts. Compare tax software Interest allocated to unborrowed policy cash value. Compare tax software Capitalization of Interest When To Deduct InterestPrepaid interest. Compare tax software Discounted loan. Compare tax software Refunds of interest. Compare tax software Prepaid interest. Compare tax software Discounted loan. Compare tax software Tax deficiency. Compare tax software Related person. Compare tax software Below-Market LoansLimit on forgone interest for gift loans of $100,000 or less. Compare tax software Introduction This chapter discusses the tax treatment of business interest expense. Compare tax software Business interest expense is an amount charged for the use of money you borrowed for business activities. Compare tax software 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. Compare tax software Sch K-1 (Form 1120S) Shareholder's Share of Income, Deductions, Credits, etc. Compare tax software 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. Compare tax software Allocation of Interest The rules for deducting interest vary, depending on whether the loan proceeds are used for business, personal, or investment activities. Compare tax software 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. Compare tax software Allocate your interest expense to the following categories. Compare tax software 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. Compare tax software You allocate loan proceeds by tracing disbursements to specific uses. Compare tax software The easiest way to trace disbursements to specific uses is to keep the proceeds of a particular loan separate from any other funds. Compare tax software Secured loan. Compare tax software   The allocation of loan proceeds and the related interest is not generally affected by the use of property that secures the loan. Compare tax software Example. Compare tax software You secure a loan with property used in your business. Compare tax software You use the loan proceeds to buy an automobile for personal use. Compare tax software You must allocate interest expense on the loan to personal use (purchase of the automobile) even though the loan is secured by business property. Compare tax software    If the property that secures the loan is your home, you generally do not allocate the loan proceeds or the related interest. Compare tax software The interest is usually deductible as qualified home mortgage interest, regardless of how the loan proceeds are used. Compare tax software For more information, see Publication 936. Compare tax software Allocation period. Compare tax software   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. Compare tax software The date the loan is repaid. Compare tax software The date the loan is reallocated to another use. Compare tax software Proceeds not disbursed to borrower. Compare tax software   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. Compare tax software This applies whether you pay for property, services, or anything else by incurring a loan, or you take property subject to a debt. Compare tax software Proceeds deposited in borrower's account. Compare tax software   Treat loan proceeds deposited in an account as property held for investment. Compare tax software It does not matter whether the account pays interest. Compare tax software Any interest you pay on the loan is investment interest expense. Compare tax software If you withdraw the proceeds of the loan, you must reallocate the loan based on the use of the funds. Compare tax software Example. Compare tax software Celina, a calendar-year taxpayer, borrows $100,000 on January 4 and immediately uses the proceeds to open a checking account. Compare tax software No other amounts are deposited in the account during the year and no part of the loan principal is repaid during the year. Compare tax software On April 2, Celina uses $20,000 from the checking account for a passive activity expenditure. Compare tax software On September 4, Celina uses an additional $40,000 from the account for personal purposes. Compare tax software 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. Compare tax software 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. Compare tax software 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. Compare tax software Order of funds spent. Compare tax software   Generally, you treat loan proceeds deposited in an account as used (spent) before either of the following amounts. Compare tax software Any unborrowed amounts held in the same account. Compare tax software Any amounts deposited after these loan proceeds. Compare tax software Example. Compare tax software On January 9, Olena opened a checking account, depositing $500 of the proceeds of Loan A and $1,000 of unborrowed funds. Compare tax software The following table shows the transactions in her account during the tax year. Compare tax software 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. Compare tax software She treats the $700 used for a passive activity as made from the remaining $200 proceeds of Loan B and $500 of unborrowed funds. Compare tax software She treats the $800 used for an investment as made entirely from the proceeds of Loan C. Compare tax software She treats the $600 used for personal purposes as made from the remaining $200 proceeds of Loan C and $400 of unborrowed funds. Compare tax software For the periods during which loan proceeds are held in the account, Olena treats them as property held for investment. Compare tax software Payments from checking accounts. Compare tax software   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. Compare tax software You can treat checks written on the same day as written in any order. Compare tax software Amounts paid within 30 days. Compare tax software   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. Compare tax software This applies to any payment made within 30 days before or after the proceeds are received in cash or deposited in your account. Compare tax software   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. Compare tax software 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. Compare tax software   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. Compare tax software Example. Compare tax software Giovanni gets a loan of $1,000 on August 4 and receives the proceeds in cash. Compare tax software 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. Compare tax software Also, Giovanni deposits his paycheck, deposits other loan proceeds, and pays his bills during the same period. Compare tax software 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. Compare tax software 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. Compare tax software Optional method for determining date of reallocation. Compare tax software   You can use the following method to determine the date loan proceeds are reallocated to another use. Compare tax software You can treat all payments from loan proceeds in the account during any month as taking place on the later of the following dates. Compare tax software The first day of that month. Compare tax software The date the loan proceeds are deposited in the account. Compare tax software 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. Compare tax software Interest on a segregated account. Compare tax software   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. Compare tax software When the interest earned is used up, any remaining payments are from loan proceeds. Compare tax software Example. Compare tax software You borrowed $20,000 and used the proceeds of this loan to open a new savings account. Compare tax software When the account had earned interest of $867, you withdrew $20,000 for personal purposes. Compare tax software 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). Compare tax software 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. Compare tax software 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. Compare tax software 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. Compare tax software Loan repayment. Compare tax software   When you repay any part of a loan allocated to more than one use, treat it as being repaid in the following order. Compare tax software Personal use. Compare tax software Investments and passive activities (other than those included in (3)). Compare tax software Passive activities in connection with a rental real estate activity in which you actively participate. Compare tax software Former passive activities. Compare tax software Trade or business use and expenses for certain low-income housing projects. Compare tax software Line of credit (continuous borrowings). Compare tax software   The following rules apply if you have a line of credit or similar arrangement. Compare tax software Treat all borrowed funds on which interest accrues at the same fixed or variable rate as a single loan. Compare tax software Treat borrowed funds or parts of borrowed funds on which interest accrues at different fixed or variable rates as different loans. Compare tax software Treat these loans as repaid in the order shown on the loan agreement. Compare tax software Loan refinancing. Compare tax software   Allocate the replacement loan to the same uses to which the repaid loan was allocated. Compare tax software Make the allocation only to the extent you use the proceeds of the new loan to repay any part of the original loan. Compare tax software Debt-financed distribution. Compare tax software   A debt-financed distribution occurs when a partnership or S corporation borrows funds and allocates those funds to distributions made to partners or shareholders. Compare tax software The manner in which you report the interest expense associated with the distributed debt proceeds depends on your use of those proceeds. Compare tax software How to report. Compare tax software   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). Compare tax software 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). Compare tax software If the proceeds were used in an investment activity, enter the interest on Form 4952. Compare tax software If the proceeds are used for personal purposes, the interest is generally not deductible. Compare tax software 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. Compare tax software Interest relates to your trade or business if you use the proceeds of the loan for a trade or business expense. Compare tax software It does not matter what type of property secures the loan. Compare tax software You can deduct interest on a debt only if you meet all the following requirements. Compare tax software You are legally liable for that debt. Compare tax software Both you and the lender intend that the debt be repaid. Compare tax software You and the lender have a true debtor-creditor relationship. Compare tax software Partial liability. Compare tax software   If you are liable for part of a business debt, you can deduct only your share of the total interest paid or accrued. Compare tax software Example. Compare tax software You and your brother borrow money. Compare tax software You are liable for 50% of the note. Compare tax software You use your half of the loan in your business, and you make one-half of the loan payments. Compare tax software You can deduct your half of the total interest payments as a business deduction. Compare tax software Mortgage. Compare tax software   Generally, mortgage interest paid or accrued on real estate you own legally or equitably is deductible. Compare tax software 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. Compare tax software Statement. Compare tax software   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. Compare tax software 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. Compare tax software A governmental unit is a person for purposes of furnishing the statement. Compare tax software   If you receive a refund of interest you overpaid in an earlier year, this amount will be reported in box 3 of Form 1098. Compare tax software You cannot deduct this amount. Compare tax software For information on how to report this refund, see Refunds of interest, later in this chapter. Compare tax software Expenses paid to obtain a mortgage. Compare tax software   Certain expenses you pay to obtain a mortgage cannot be deducted as interest. Compare tax software These expenses, which include mortgage commissions, abstract fees, and recording fees, are capital expenses. Compare tax software If the property mortgaged is business or income-producing property, you can amortize the costs over the life of the mortgage. Compare tax software Prepayment penalty. Compare tax software   If you pay off your mortgage early and pay the lender a penalty for doing this, you can deduct the penalty as interest. Compare tax software Interest on employment tax deficiency. Compare tax software   Interest charged on employment taxes assessed on your business is deductible. Compare tax software Original issue discount (OID). Compare tax software   OID is a form of interest. Compare tax software A loan (mortgage or other debt) generally has OID when its proceeds are less than its principal amount. Compare tax software The OID is the difference between the stated redemption price at maturity and the issue price of the loan. Compare tax software   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. Compare tax software 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. Compare tax software You generally deduct OID over the term of the loan. Compare tax software Figure the amount to deduct each year using the constant-yield method, unless the OID on the loan is de minimis. Compare tax software De minimis OID. Compare tax software   The OID is de minimis if it is less than one-fourth of 1% (. Compare tax software 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). Compare tax software   If the OID is de minimis, you can choose one of the following ways to figure the amount you can deduct each year. Compare tax software On a constant-yield basis over the term of the loan. Compare tax software On a straight-line basis over the term of the loan. Compare tax software In proportion to stated interest payments. Compare tax software In its entirety at maturity of the loan. Compare tax software 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. Compare tax software Example. Compare tax software On January 1, 2013, you took out a $100,000 discounted loan and received $98,500 in proceeds. Compare tax software The loan will mature on January 1, 2023 (a 10-year term), and the $100,000 principal is payable on that date. Compare tax software Interest of $10,000 is payable on January 1 of each year, beginning January 1, 2014. Compare tax software The $1,500 OID on the loan is de minimis because it is less than $2,500 ($100,000 × . Compare tax software 0025 × 10). Compare tax software You choose to deduct the OID on a straight-line basis over the term of the loan. Compare tax software Beginning in 2013, you can deduct $150 each year for 10 years. Compare tax software Constant-yield method. Compare tax software   If the OID is not de minimis, you must use the constant-yield method to figure how much you can deduct each year. Compare tax software You figure your deduction for the first year using the following steps. Compare tax software Determine the issue price of the loan. Compare tax software Generally, this equals the proceeds of the loan. Compare tax software If you paid points on the loan (as discussed later), the issue price generally is the difference between the proceeds and the points. Compare tax software Multiply the result in (1) by the yield to maturity. Compare tax software Subtract any qualified stated interest payments from the result in (2). Compare tax software This is the OID you can deduct in the first year. Compare tax software   To figure your deduction in any subsequent year, follow the above steps, except determine the adjusted issue price in step (1). Compare tax software To get the adjusted issue price, add to the issue price any OID previously deducted. Compare tax software Then follow steps (2) and (3) above. Compare tax software   The yield to maturity is generally shown in the literature you receive from your lender. Compare tax software If you do not have this information, consult your lender or tax advisor. Compare tax software 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. Compare tax software Example. Compare tax software 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. Compare tax software The yield to maturity on your loan is 10. Compare tax software 2467%, compounded annually. Compare tax software For 2013, you can deduct $93 [($98,500 × . Compare tax software 102467) − $10,000]. Compare tax software For 2014, you can deduct $103 [($98,593 × . Compare tax software 102467) − $10,000]. Compare tax software Loan or mortgage ends. Compare tax software   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. Compare tax software A loan or mortgage may end due to a refinancing, prepayment, foreclosure, or similar event. Compare tax software 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. Compare tax software See Interest paid with funds borrowed from original lender under Interest You Cannot Deduct, later. Compare tax software Points. Compare tax software   The term “points” is used to describe certain charges paid, or treated as paid, by a borrower to obtain a loan or a mortgage. Compare tax software These charges are also called loan origination fees, maximum loan charges, discount points, or premium charges. Compare tax software If any of these charges (points) are solely for the use of money, they are interest. Compare tax software   Because points are prepaid interest, you generally cannot deduct the full amount in the year paid. Compare tax software However, you can choose to fully deduct points in the year paid if you meet certain tests. Compare tax software For exceptions to the general rule, see Publication 936. Compare tax software The points reduce the issue price of the loan and result in original issue discount (OID), deductible as explained in the preceding discussion. Compare tax software Partial payments on a nontax debt. Compare tax software   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. Compare tax software You can deduct only the interest. Compare tax software 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. Compare tax software Installment purchase. Compare tax software   If you make an installment purchase of business property, the contract between you and the seller generally provides for the payment of interest. Compare tax software 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). Compare tax software The amount recharacterized as interest reduces your basis in the property and increases your interest expense. Compare tax software For more information on installment sales and unstated interest, see Publication 537. Compare tax software Interest You Cannot Deduct Certain interest payments cannot be deducted. Compare tax software In addition, certain other expenses that may seem to be interest but are not, cannot be deducted as interest. Compare tax software You cannot currently deduct interest that must be capitalized, and you generally cannot deduct personal interest. Compare tax software Interest paid with funds borrowed from original lender. Compare tax software   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. Compare tax software You can deduct the interest expense once you start making payments on the new loan. Compare tax software   When you make a payment on the new loan, you first apply the payment to interest and then to the principal. Compare tax software 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. Compare tax software Capitalized interest. Compare tax software   You cannot currently deduct interest you are required to capitalize under the uniform capitalization rules. Compare tax software See Capitalization of Interest, later. Compare tax software 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. Compare tax software Add this interest to the basis of the property. Compare tax software Commitment fees or standby charges. Compare tax software   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. Compare tax software You may be able to deduct them as business expenses. Compare tax software   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. Compare tax software See Capitalization of Interest, later. Compare tax software Interest on income tax. Compare tax software   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. Compare tax software Treat this interest as a business deduction only in figuring a net operating loss deduction. Compare tax software Penalties. Compare tax software   Penalties on underpaid deficiencies and underpaid estimated tax are not interest. Compare tax software You cannot deduct them. Compare tax software Generally, you cannot deduct any fines or penalties. Compare tax software Interest on loans with respect to life insurance policies. Compare tax software   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. Compare tax software   If the policy or contract covers a key person, you can deduct the interest on up to $50,000 of debt for that person. Compare tax software 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. Compare tax software Who is a key person?   A key person is an officer or 20% owner. Compare tax software However, the number of individuals you can treat as key persons is limited to the greater of the following. Compare tax software Five individuals. Compare tax software The lesser of 5% of the total officers and employees of the company or 20 individuals. Compare tax software Exceptions for pre-June 1997 contracts. Compare tax software   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. Compare tax software If the contract was purchased before June 21, 1986, you can generally deduct the interest no matter who is covered by the contract. Compare tax software Interest allocated to unborrowed policy cash value. Compare tax software   Corporations and partnerships generally cannot deduct any interest expense allocable to unborrowed cash values of life insurance, annuity, or endowment contracts. Compare tax software This rule applies to contracts issued after June 8, 1997, that cover someone other than an officer, director, employee, or 20% owner. Compare tax software For more information, see section 264(f) of the Internal Revenue Code. Compare tax software 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. Compare tax software The property must be produced by you for use in your trade or business or for sale to customers. Compare tax software You cannot capitalize interest related to property that you acquire in any other manner. Compare tax software Interest you paid or incurred during the production period must be capitalized if the property produced is designated property. Compare tax software Designated property is any of the following. Compare tax software Real property. Compare tax software Tangible personal property with a class life of 20 years or more. Compare tax software Tangible personal property with an estimated production period of more than 2 years. Compare tax software Tangible personal property with an estimated production period of more than 1 year if the estimated cost of production is more than $1 million. Compare tax software Property you produce. Compare tax software   You produce property if you construct, build, install, manufacture, develop, improve, create, raise, or grow it. Compare tax software Treat property produced for you under a contract as produced by you up to the amount you pay or incur for the property. Compare tax software Carrying charges. Compare tax software   Carrying charges include taxes you pay to carry or develop real estate or to carry, transport, or install personal property. Compare tax software You can choose to capitalize carrying charges not subject to the uniform capitalization rules if they are otherwise deductible. Compare tax software For more information, see chapter 7. Compare tax software Capitalized interest. Compare tax software   Treat capitalized interest as a cost of the property produced. Compare tax software You recover your interest when you sell or use the property. Compare tax software If the property is inventory, recover capitalized interest through cost of goods sold. Compare tax software If the property is used in your trade or business, recover capitalized interest through an adjustment to basis, depreciation, amortization, or other method. Compare tax software Partnerships and S corporations. Compare tax software   The interest capitalization rules are applied first at the partnership or S corporation level. Compare tax software 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. Compare tax software   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. Compare tax software You may also have to capitalize interest incurred by the partnership or S corporation for your own production costs. Compare tax software 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. Compare tax software Additional information. Compare tax software   The procedures for applying the uniform capitalization rules are beyond the scope of this publication. Compare tax software For more information, see sections 1. Compare tax software 263A-8 through 1. Compare tax software 263A-15 of the regulations and Notice 88-99. Compare tax software Notice 88-99 is in Cumulative Bulletin 1988-2. Compare tax software When To Deduct Interest If the uniform capitalization rules, discussed under Capitalization of Interest, earlier, do not apply to you, deduct interest as follows. Compare tax software Cash method. Compare tax software   Under the cash method, you can generally deduct only the interest you actually paid during the tax year. Compare tax software You cannot deduct a promissory note you gave as payment because it is a promise to pay and not an actual payment. Compare tax software Prepaid interest. Compare tax software   You generally cannot deduct any interest paid before the year it is due. Compare tax software Interest paid in advance can be deducted only in the tax year in which it is due. Compare tax software Discounted loan. Compare tax software   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. Compare tax software For more information, see Original issue discount (OID) under Interest You Can Deduct, earlier. Compare tax software Refunds of interest. Compare tax software   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. Compare tax software 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. Compare tax software Accrual method. Compare tax software   Under an accrual method, you can deduct only interest that has accrued during the tax year. Compare tax software Prepaid interest. Compare tax software   See Prepaid interest, earlier. Compare tax software Discounted loan. Compare tax software   See Discounted loan, earlier. Compare tax software Tax deficiency. Compare tax software   If you contest a federal income tax deficiency, interest does not accrue until the tax year the final determination of liability is made. Compare tax software If you do not contest the deficiency, then the interest accrues in the year the tax was asserted and agreed to by you. Compare tax software   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. Compare tax software Related person. Compare tax software   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. Compare tax software The relationship is determined as of the end of the tax year for which the interest would otherwise be deductible. Compare tax software See section 267 of the Internal Revenue Code for more information. Compare tax software 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. Compare tax software See Treatment of gift and demand loans, later, in this discussion. Compare tax software 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. Compare tax software 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. Compare tax software A loan in exchange for a note that requires the payment of interest at the applicable federal rate. Compare tax software An additional payment in an amount equal to the forgone interest. Compare tax software 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. Compare tax software Forgone interest. Compare tax software   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. Compare tax software Applicable federal rates are published by the IRS each month in the Internal Revenue Bulletin. Compare tax software Internal Revenue Bulletins are available on the IRS web site at www. Compare tax software irs. Compare tax software gov/irb. Compare tax software You can also contact an IRS office to get these rates. Compare tax software Loans subject to the rules. Compare tax software   The rules for below-market loans apply to the following. Compare tax software Gift loans (below-market loans where the forgone interest is in the nature of a gift). Compare tax software 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). Compare tax software Corporation-shareholder loans. Compare tax software Tax avoidance loans (below-market loans where the avoidance of federal tax is one of the main purposes of the interest arrangement). Compare tax software Loans to qualified continuing care facilities under a continuing care contract (made after October 11, 1985). Compare tax software   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. Compare tax software Treatment of gift and demand loans. Compare tax software   If you receive a below-market gift loan or demand loan, you are treated as receiving an additional payment (as a gift, dividend, etc. Compare tax software ) equal to the forgone interest on the loan. Compare tax software You are then treated as transferring this amount back to the lender as interest. Compare tax software These transfers are considered to occur annually, generally on December 31. Compare tax software If you use the loan proceeds in your trade or business, you can deduct the forgone interest each year as a business interest expense. Compare tax software The lender must report it as interest income. Compare tax software Limit on forgone interest for gift loans of $100,000 or less. Compare tax software   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. Compare tax software This limit applies if the outstanding loans between the lender and borrower total $100,000 or less. Compare tax software If the borrower's net investment income is $1,000 or less, it is treated as zero. Compare tax software 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. Compare tax software Treatment of term loans. Compare tax software   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. Compare tax software ) on the date the loan is made. Compare tax software This payment is equal to the loan amount minus the present value, at the applicable federal rate, of all payments due under the loan. Compare tax software The same amount is treated as original issue discount on the loan. Compare tax software See Original issue discount (OID) under Interest You Can Deduct, earlier. Compare tax software Exceptions for loans of $10,000 or less. Compare tax software   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. Compare tax software This exception applies only to the following. Compare tax software Gift loans between individuals if the loan is not directly used to buy or carry income-producing assets. Compare tax software Compensation-related loans or corporation-shareholder loans if the avoidance of any federal tax is not a principal purpose of the interest arrangement. Compare tax software This exception does not apply to a term loan described in (2) above that was previously subject to the below-market loan rules. Compare tax software Those rules will continue to apply even if the outstanding balance is reduced to $10,000 or less. Compare tax software Exceptions for loans without significant tax effect. Compare tax software   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. Compare tax software 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. Compare tax software Loans subsidized by a federal, state, or municipal government that are made available under a program of general application to the public. Compare tax software Certain employee-relocation loans. Compare tax software Certain loans to or from a foreign person, unless the interest income would be effectively connected with the conduct of a U. Compare tax software S. Compare tax software trade or business and not exempt from U. Compare tax software S. Compare tax software tax under an income tax treaty. Compare tax software 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. Compare tax software 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. Compare tax software Consider all the following factors. Compare tax software Whether items of income and deduction generated by the loan offset each other. Compare tax software The amount of the items. Compare tax software The cost of complying with the below-market loan provisions if they were to apply. Compare tax software Any reasons, other than taxes, for structuring the transaction as a below-market loan. Compare tax software Exception for loans to qualified continuing care facilities. Compare tax software   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. Compare tax software A qualified continuing care facility is one or more facilities (excluding nursing homes) meeting the requirements listed below. Compare tax software Designed to provide services under continuing care contracts (defined below). Compare tax software Includes an independent living unit, and either an assisted living or nursing facility, or both. Compare tax software Substantially all of the independent living unit residents are covered by continuing care contracts. Compare tax software A continuing care contract is a written contract between an individual and a qualified continuing care facility that includes all of the following conditions. Compare tax software The individual or individual's spouse must be entitled to use the facility for the rest of their life or lives. Compare tax software 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. Compare tax software 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. Compare tax software For more information, see section 7872(h) of the Internal Revenue Code. Compare tax software Sale or exchange of property. Compare tax software   Different rules generally apply to a loan connected with the sale or exchange of property. Compare tax software If the loan does not provide adequate stated interest, part of the principal payment may be considered interest. Compare tax software However, there are exceptions that may require you to apply the below-market interest rate rules to these loans. Compare tax software See Unstated Interest and Original Issue Discount (OID) in Publication 537. Compare tax software More information. Compare tax software   For more information on below-market loans, see section 7872 of the Internal Revenue Code and section 1. Compare tax software 7872-5 of the regulations. Compare tax software Prev  Up  Next   Home   More Online Publications