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H&r Block 2012 Taxes

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H&r Block 2012 Taxes

H&r block 2012 taxes 2. H&r block 2012 taxes   Ordinary or Capital Gain or Loss Table of Contents IntroductionSection 1231 transactions. H&r block 2012 taxes Topics - This chapter discusses: Useful Items - You may want to see: Capital Assets Noncapital AssetsCommodities derivative dealer. H&r block 2012 taxes Sales and Exchanges Between Related PersonsGain Is Ordinary Income Nondeductible Loss Other DispositionsSale of a Business Dispositions of Intangible Property Subdivision of Land Timber Precious Metals and Stones, Stamps, and Coins Coal and Iron Ore Conversion Transactions Introduction You must classify your gains and losses as either ordinary or capital (and your capital gains or losses as either short-term or long-term). H&r block 2012 taxes You must do this to figure your net capital gain or loss. H&r block 2012 taxes For individuals, a net capital gain may be taxed at a different tax rate than ordinary income. H&r block 2012 taxes See Capital Gains Tax Rates in chapter 4. H&r block 2012 taxes Your deduction for a net capital loss may be limited. H&r block 2012 taxes See Treatment of Capital Losses in chapter 4. H&r block 2012 taxes Capital gain or loss. H&r block 2012 taxes   Generally, you will have a capital gain or loss if you sell or exchange a capital asset. H&r block 2012 taxes You also may have a capital gain if your section 1231 transactions result in a net gain. H&r block 2012 taxes Section 1231 transactions. H&r block 2012 taxes   Section 1231 transactions are sales and exchanges of property held longer than 1 year and either used in a trade or business or held for the production of rents or royalties. H&r block 2012 taxes They also include certain involuntary conversions of business or investment property, including capital assets. H&r block 2012 taxes See Section 1231 Gains and Losses in chapter 3 for more information. H&r block 2012 taxes Topics - This chapter discusses: Capital assets Noncapital assets Sales and exchanges between  related persons Other dispositions Useful Items - You may want to see: Publication 550 Investment Income and Expenses Form (and Instructions) Schedule D (Form 1040) Capital Gains and Losses 4797 Sales of Business Property 8594 Asset Acquisition Statement Under Section 1060 8949 Sales and Other Dispositions of Capital Assets See chapter 5 for information about getting publications and forms. H&r block 2012 taxes Capital Assets Almost everything you own and use for personal purposes, pleasure, or investment is a capital asset. H&r block 2012 taxes For exceptions, see Noncapital Assets, later. H&r block 2012 taxes The following items are examples of capital assets. H&r block 2012 taxes Stocks and bonds. H&r block 2012 taxes A home owned and occupied by you and your family. H&r block 2012 taxes Timber grown on your home property or investment property, even if you make casual sales of the timber. H&r block 2012 taxes Household furnishings. H&r block 2012 taxes A car used for pleasure or commuting. H&r block 2012 taxes Coin or stamp collections. H&r block 2012 taxes Gems and jewelry. H&r block 2012 taxes Gold, silver, and other metals. H&r block 2012 taxes Personal-use property. H&r block 2012 taxes   Generally, property held for personal use is a capital asset. H&r block 2012 taxes Gain from a sale or exchange of that property is a capital gain. H&r block 2012 taxes Loss from the sale or exchange of that property is not deductible. H&r block 2012 taxes You can deduct a loss relating to personal-use property only if it results from a casualty or theft. H&r block 2012 taxes Investment property. H&r block 2012 taxes   Investment property (such as stocks and bonds) is a capital asset, and a gain or loss from its sale or exchange is a capital gain or loss. H&r block 2012 taxes This treatment does not apply to property used to produce rental income. H&r block 2012 taxes See Business assets, later, under Noncapital Assets. H&r block 2012 taxes Release of restriction on land. H&r block 2012 taxes   Amounts you receive for the release of a restrictive covenant in a deed to land are treated as proceeds from the sale of a capital asset. H&r block 2012 taxes Noncapital Assets A noncapital asset is property that is not a capital asset. H&r block 2012 taxes The following kinds of property are not capital assets. H&r block 2012 taxes Stock in trade, inventory, and other property you hold mainly for sale to customers in your trade or business. H&r block 2012 taxes Inventories are discussed in Publication 538, Accounting Periods and Methods. H&r block 2012 taxes But, see the Tip below. H&r block 2012 taxes Accounts or notes receivable acquired in the ordinary course of a trade or business for services rendered or from the sale of any properties described in (1), above. H&r block 2012 taxes Depreciable property used in your trade or business or as rental property (including section 197 intangibles defined later), even if the property is fully depreciated (or amortized). H&r block 2012 taxes Sales of this type of property are discussed in chapter 3. H&r block 2012 taxes Real property used in your trade or business or as rental property, even if the property is fully depreciated. H&r block 2012 taxes A copyright; a literary, musical, or artistic composition; a letter; a memorandum; or similar property (such as drafts of speeches, recordings, transcripts, manuscripts, drawings, or photographs): Created by your personal efforts, Prepared or produced for you (in the case of a letter, memorandum, or similar property), or Received from a person who created the property or for whom the property was prepared under circumstances (for example, by gift) entitling you to the basis of the person who created the property, or for whom it was prepared or produced. H&r block 2012 taxes But, see the Tip below. H&r block 2012 taxes U. H&r block 2012 taxes S. H&r block 2012 taxes Government publications you got from the government for free or for less than the normal sales price or that you acquired under circumstances entitling you to the basis of someone who got the publications for free or for less than the normal sales price. H&r block 2012 taxes Any commodities derivative financial instrument (discussed later) held by a commodities derivatives dealer unless it meets both of the following requirements. H&r block 2012 taxes It is established to the satisfaction of the IRS that the instrument has no connection to the activities of the dealer as a dealer. H&r block 2012 taxes The instrument is clearly identified in the dealer's records as meeting (a) by the end of the day on which it was acquired, originated, or entered into. H&r block 2012 taxes Any hedging transaction (defined later) that is clearly identified as a hedging transaction by the end of the day on which it was acquired, originated, or entered into. H&r block 2012 taxes Supplies of a type you regularly use or consume in the ordinary course of your trade or business. H&r block 2012 taxes You can elect to treat as capital assets certain self-created musical compositions or copyrights you sold or exchanged. H&r block 2012 taxes See chapter 4 of Publication 550 for details. H&r block 2012 taxes Property held mainly for sale to customers. H&r block 2012 taxes   Stock in trade, inventory, and other property you hold mainly for sale to customers in your trade or business are not capital assets. H&r block 2012 taxes Inventories are discussed in Publication 538. H&r block 2012 taxes Business assets. H&r block 2012 taxes   Real property and depreciable property used in your trade or business or as rental property (including section 197 intangibles defined later under Dispositions of Intangible Property) are not capital assets. H&r block 2012 taxes The sale or disposition of business property is discussed in chapter 3. H&r block 2012 taxes Letters and memoranda. H&r block 2012 taxes   Letters, memoranda, and similar property (such as drafts of speeches, recordings, transcripts, manuscripts, drawings, or photographs) are not treated as capital assets (as discussed earlier) if your personal efforts created them or if they were prepared or produced for you. H&r block 2012 taxes Nor is this property a capital asset if your basis in it is determined by reference to the person who created it or the person for whom it was prepared. H&r block 2012 taxes For this purpose, letters and memoranda addressed to you are considered prepared for you. H&r block 2012 taxes If letters or memoranda are prepared by persons under your administrative control, they are considered prepared for you whether or not you review them. H&r block 2012 taxes Commodities derivative financial instrument. H&r block 2012 taxes   A commodities derivative financial instrument is a commodities contract or other financial instrument for commodities (other than a share of corporate stock, a beneficial interest in a partnership or trust, a note, bond, debenture, or other evidence of indebtedness, or a section 1256 contract) the value or settlement price of which is calculated or determined by reference to a specified index (as defined in section 1221(b) of the Internal Revenue Code). H&r block 2012 taxes Commodities derivative dealer. H&r block 2012 taxes   A commodities derivative dealer is a person who regularly offers to enter into, assume, offset, assign, or terminate positions in commodities derivative financial instruments with customers in the ordinary course of a trade or business. H&r block 2012 taxes Hedging transaction. H&r block 2012 taxes   A hedging transaction is any transaction you enter into in the normal course of your trade or business primarily to manage any of the following. H&r block 2012 taxes Risk of price changes or currency fluctuations involving ordinary property you hold or will hold. H&r block 2012 taxes Risk of interest rate or price changes or currency fluctuations for borrowings you make or will make, or ordinary obligations you incur or will incur. H&r block 2012 taxes Sales and Exchanges Between Related Persons This section discusses the rules that may apply to the sale or exchange of property between related persons. H&r block 2012 taxes If these rules apply, gains may be treated as ordinary income and losses may not be deductible. H&r block 2012 taxes See Transfers to Spouse in chapter 1 for rules that apply to spouses. H&r block 2012 taxes Gain Is Ordinary Income If a gain is recognized on the sale or exchange of property to a related person, the gain may be ordinary income even if the property is a capital asset. H&r block 2012 taxes It is ordinary income if the sale or exchange is a depreciable property transaction or a controlled partnership transaction. H&r block 2012 taxes Depreciable property transaction. H&r block 2012 taxes   Gain on the sale or exchange of property, including a leasehold or a patent application, that is depreciable property in the hands of the person who receives it is ordinary income if the transaction is either directly or indirectly between any of the following pairs of entities. H&r block 2012 taxes A person and the person's controlled entity or entities. H&r block 2012 taxes A taxpayer and any trust in which the taxpayer (or his or her spouse) is a beneficiary unless the beneficiary's interest in the trust is a remote contingent interest; that is, the value of the interest computed actuarially is 5% or less of the value of the trust property. H&r block 2012 taxes An executor and a beneficiary of an estate unless the sale or exchange is in satisfaction of a pecuniary bequest (a bequest for a sum of money). H&r block 2012 taxes An employer (or any person related to the employer under rules (1), (2), or (3)) and a welfare benefit fund (within the meaning of section 419(e) of the Internal Revenue Code) that is controlled directly or indirectly by the employer (or any person related to the employer). H&r block 2012 taxes Controlled entity. H&r block 2012 taxes   A person's controlled entity is either of the following. H&r block 2012 taxes A corporation in which more than 50% of the value of all outstanding stock, or a partnership in which more than 50% of the capital interest or profits interest, is directly or indirectly owned by or for that person. H&r block 2012 taxes An entity whose relationship with that person is one of the following. H&r block 2012 taxes A corporation and a partnership if the same persons own more than 50% in value of the outstanding stock of the corporation and more than 50% of the capital interest or profits interest in the partnership. H&r block 2012 taxes Two corporations that are members of the same controlled group as defined in section 1563(a) of the Internal Revenue Code, except that “more than 50%” is substituted for “at least 80%” in that definition. H&r block 2012 taxes Two S corporations, if the same persons own more than 50% in value of the outstanding stock of each corporation. H&r block 2012 taxes Two corporations, one of which is an S corporation, if the same persons own more than 50% in value of the outstanding stock of each corporation. H&r block 2012 taxes Controlled partnership transaction. H&r block 2012 taxes   A gain recognized in a controlled partnership transaction may be ordinary income. H&r block 2012 taxes The gain is ordinary income if it results from the sale or exchange of property that, in the hands of the party who receives it, is a noncapital asset such as trade accounts receivable, inventory, stock in trade, or depreciable or real property used in a trade or business. H&r block 2012 taxes   A controlled partnership transaction is a transaction directly or indirectly between either of the following pairs of entities. H&r block 2012 taxes A partnership and a person who directly or indirectly owns more than 50% of the capital interest or profits interest in the partnership. H&r block 2012 taxes Two partnerships, if the same persons directly or indirectly own more than 50% of the capital interests or profits interests in both partnerships. H&r block 2012 taxes Determining ownership. H&r block 2012 taxes   In the transactions under Depreciable property transaction and Controlled partnership transaction, earlier, use the following rules to determine the ownership of stock or a partnership interest. H&r block 2012 taxes Stock or a partnership interest directly or indirectly owned by or for a corporation, partnership, estate, or trust is considered owned proportionately by or for its shareholders, partners, or beneficiaries. H&r block 2012 taxes (However, for a partnership interest owned by or for a C corporation, this applies only to shareholders who directly or indirectly own 5% or more in value of the stock of the corporation. H&r block 2012 taxes ) An individual is considered as owning the stock or partnership interest directly or indirectly owned by or for his or her family. H&r block 2012 taxes Family includes only brothers, sisters, half-brothers, half-sisters, spouse, ancestors, and lineal descendants. H&r block 2012 taxes For purposes of applying (1) or (2), above, stock or a partnership interest constructively owned by a person under (1) is treated as actually owned by that person. H&r block 2012 taxes But stock or a partnership interest constructively owned by an individual under (2) is not treated as owned by the individual for reapplying (2) to make another person the constructive owner of that stock or partnership interest. H&r block 2012 taxes Nondeductible Loss A loss on the sale or exchange of property between related persons is not deductible. H&r block 2012 taxes This applies to both direct and indirect transactions, but not to distributions of property from a corporation in a complete liquidation. H&r block 2012 taxes For the list of related persons, see Related persons next. H&r block 2012 taxes If a sale or exchange is between any of these related persons and involves the lump-sum sale of a number of blocks of stock or pieces of property, the gain or loss must be figured separately for each block of stock or piece of property. H&r block 2012 taxes The gain on each item is taxable. H&r block 2012 taxes The loss on any item is nondeductible. H&r block 2012 taxes Gains from the sales of any of these items may not be offset by losses on the sales of any of the other items. H&r block 2012 taxes Related persons. H&r block 2012 taxes   The following is a list of related persons. H&r block 2012 taxes Members of a family, including only brothers, sisters, half-brothers, half-sisters, spouse, ancestors (parents, grandparents, etc. H&r block 2012 taxes ), and lineal descendants (children, grandchildren, etc. H&r block 2012 taxes ). H&r block 2012 taxes An individual and a corporation if the individual directly or indirectly owns more than 50% in value of the outstanding stock of the corporation. H&r block 2012 taxes Two corporations that are members of the same controlled group as defined in section 267(f) of the Internal Revenue Code. H&r block 2012 taxes A trust fiduciary and a corporation if the trust or the grantor of the trust directly or indirectly owns more than 50% in value of the outstanding stock of the corporation. H&r block 2012 taxes A grantor and fiduciary, and the fiduciary and beneficiary, of any trust. H&r block 2012 taxes Fiduciaries of two different trusts, and the fiduciary and beneficiary of two different trusts, if the same person is the grantor of both trusts. H&r block 2012 taxes A tax-exempt educational or charitable organization and a person who directly or indirectly controls the organization, or a member of that person's family. H&r block 2012 taxes A corporation and a partnership if the same persons own more than 50% in value of the outstanding stock of the corporation and more than 50% of the capital interest or profits interest in the partnership. H&r block 2012 taxes Two S corporations if the same persons own more than 50% in value of the outstanding stock of each corporation. H&r block 2012 taxes Two corporations, one of which is an S corporation, if the same persons own more than 50% in value of the outstanding stock of each corporation. H&r block 2012 taxes An executor and a beneficiary of an estate unless the sale or exchange is in satisfaction of a pecuniary bequest. H&r block 2012 taxes Two partnerships if the same persons directly or indirectly own more than 50% of the capital interests or profits interests in both partnerships. H&r block 2012 taxes A person and a partnership if the person directly or indirectly owns more than 50% of the capital interest or profits interest in the partnership. H&r block 2012 taxes Partnership interests. H&r block 2012 taxes   The nondeductible loss rule does not apply to a sale or exchange of an interest in the partnership between the related persons described in (12) or (13) above. H&r block 2012 taxes Controlled groups. H&r block 2012 taxes   Losses on transactions between members of the same controlled group described in (3) earlier are deferred rather than denied. H&r block 2012 taxes   For more information, see section 267(f) of the Internal Revenue Code. H&r block 2012 taxes Ownership of stock or partnership interests. H&r block 2012 taxes   In determining whether an individual directly or indirectly owns any of the outstanding stock of a corporation or an interest in a partnership for a loss on a sale or exchange, the following rules apply. H&r block 2012 taxes Stock or a partnership interest directly or indirectly owned by or for a corporation, partnership, estate, or trust is considered owned proportionately by or for its shareholders, partners, or beneficiaries. H&r block 2012 taxes (However, for a partnership interest owned by or for a C corporation, this applies only to shareholders who directly or indirectly own 5% or more in value of the stock of the corporation. H&r block 2012 taxes ) An individual is considered as owning the stock or partnership interest directly or indirectly owned by or for his or her family. H&r block 2012 taxes Family includes only brothers, sisters, half-brothers, half-sisters, spouse, ancestors, and lineal descendants. H&r block 2012 taxes An individual owning (other than by applying (2)) any stock in a corporation is considered to own the stock directly or indirectly owned by or for his or her partner. H&r block 2012 taxes For purposes of applying (1), (2), or (3), stock or a partnership interest constructively owned by a person under (1) is treated as actually owned by that person. H&r block 2012 taxes But stock or a partnership interest constructively owned by an individual under (2) or (3) is not treated as owned by the individual for reapplying either (2) or (3) to make another person the constructive owner of that stock or partnership interest. H&r block 2012 taxes Indirect transactions. H&r block 2012 taxes   You cannot deduct your loss on the sale of stock through your broker if under a prearranged plan a related person or entity buys the same stock you had owned. H&r block 2012 taxes This does not apply to a cross-trade between related parties through an exchange that is purely coincidental and is not prearranged. H&r block 2012 taxes Property received from a related person. H&r block 2012 taxes   If, in a purchase or exchange, you received property from a related person who had a loss that was not allowable and you later sell or exchange the property at a gain, you recognize the gain only to the extent it is more than the loss previously disallowed to the related person. H&r block 2012 taxes This rule applies only to the original transferee. H&r block 2012 taxes Example 1. H&r block 2012 taxes Your brother sold stock to you for $7,600. H&r block 2012 taxes His cost basis was $10,000. H&r block 2012 taxes His loss of $2,400 was not deductible. H&r block 2012 taxes You later sell the same stock to an unrelated party for $10,500, realizing a gain of $2,900 ($10,500 − $7,600). H&r block 2012 taxes Your recognized gain is only $500, the gain that is more than the $2,400 loss not allowed to your brother. H&r block 2012 taxes Example 2. H&r block 2012 taxes Assume the same facts as in Example 1, except that you sell the stock for $6,900 instead of $10,500. H&r block 2012 taxes Your recognized loss is only $700 ($7,600 − $6,900). H&r block 2012 taxes You cannot deduct the loss not allowed to your brother. H&r block 2012 taxes Other Dispositions This section discusses rules for determining the treatment of gain or loss from various dispositions of property. H&r block 2012 taxes Sale of a Business The sale of a business usually is not a sale of one asset. H&r block 2012 taxes Instead, all the assets of the business are sold. H&r block 2012 taxes Generally, when this occurs, each asset is treated as being sold separately for determining the treatment of gain or loss. H&r block 2012 taxes A business usually has many assets. H&r block 2012 taxes When sold, these assets must be classified as capital assets, depreciable property used in the business, real property used in the business, or property held for sale to customers, such as inventory or stock in trade. H&r block 2012 taxes The gain or loss on each asset is figured separately. H&r block 2012 taxes The sale of capital assets results in capital gain or loss. H&r block 2012 taxes The sale of real property or depreciable property used in the business and held longer than 1 year results in gain or loss from a section 1231 transaction (discussed in chapter 3). H&r block 2012 taxes The sale of inventory results in ordinary income or loss. H&r block 2012 taxes Partnership interests. H&r block 2012 taxes   An interest in a partnership or joint venture is treated as a capital asset when sold. H&r block 2012 taxes The part of any gain or loss from unrealized receivables or inventory items will be treated as ordinary gain or loss. H&r block 2012 taxes For more information, see Disposition of Partner's Interest in Publication 541. H&r block 2012 taxes Corporation interests. H&r block 2012 taxes   Your interest in a corporation is represented by stock certificates. H&r block 2012 taxes When you sell these certificates, you usually realize capital gain or loss. H&r block 2012 taxes For information on the sale of stock, see chapter 4 in Publication 550. H&r block 2012 taxes Corporate liquidations. H&r block 2012 taxes   Corporate liquidations of property generally are treated as a sale or exchange. H&r block 2012 taxes Gain or loss generally is recognized by the corporation on a liquidating sale of its assets. H&r block 2012 taxes Gain or loss generally is recognized also on a liquidating distribution of assets as if the corporation sold the assets to the distributee at fair market value. H&r block 2012 taxes   In certain cases in which the distributee is a corporation in control of the distributing corporation, the distribution may not be taxable. H&r block 2012 taxes For more information, see section 332 of the Internal Revenue Code and the related regulations. H&r block 2012 taxes Allocation of consideration paid for a business. H&r block 2012 taxes   The sale of a trade or business for a lump sum is considered a sale of each individual asset rather than of a single asset. H&r block 2012 taxes Except for assets exchanged under any nontaxable exchange rules, both the buyer and seller of a business must use the residual method (explained later) to allocate the consideration to each business asset transferred. H&r block 2012 taxes This method determines gain or loss from the transfer of each asset and how much of the consideration is for goodwill and certain other intangible property. H&r block 2012 taxes It also determines the buyer's basis in the business assets. H&r block 2012 taxes Consideration. H&r block 2012 taxes   The buyer's consideration is the cost of the assets acquired. H&r block 2012 taxes The seller's consideration is the amount realized (money plus the fair market value of property received) from the sale of assets. H&r block 2012 taxes Residual method. H&r block 2012 taxes   The residual method must be used for any transfer of a group of assets that constitutes a trade or business and for which the buyer's basis is determined only by the amount paid for the assets. H&r block 2012 taxes This applies to both direct and indirect transfers, such as the sale of a business or the sale of a partnership interest in which the basis of the buyer's share of the partnership assets is adjusted for the amount paid under section 743(b) of the Internal Revenue Code. H&r block 2012 taxes Section 743(b) applies if a partnership has an election in effect under section 754 of the Internal Revenue Code. H&r block 2012 taxes   A group of assets constitutes a trade or business if either of the following applies. H&r block 2012 taxes Goodwill or going concern value could, under any circumstances, attach to them. H&r block 2012 taxes The use of the assets would constitute an active trade or business under section 355 of the Internal Revenue Code. H&r block 2012 taxes   The residual method provides for the consideration to be reduced first by the amount of Class I assets (defined below). H&r block 2012 taxes The consideration remaining after this reduction must be allocated among the various business assets in a certain order. H&r block 2012 taxes See Classes of assets next for the complete order. H&r block 2012 taxes Classes of assets. H&r block 2012 taxes   The following definitions are the classifications for deemed or actual asset acquisitions. H&r block 2012 taxes Allocate the consideration among the assets in the following order. H&r block 2012 taxes The amount allocated to an asset, other than a Class VII asset, cannot exceed its fair market value on the purchase date. H&r block 2012 taxes The amount you can allocate to an asset also is subject to any applicable limits under the Internal Revenue Code or general principles of tax law. H&r block 2012 taxes Class I assets are cash and general deposit accounts (including checking and savings accounts but excluding certificates of deposit). H&r block 2012 taxes Class II assets are certificates of deposit, U. H&r block 2012 taxes S. H&r block 2012 taxes Government securities, foreign currency, and actively traded personal property, including stock and securities. H&r block 2012 taxes Class III assets are accounts receivable, other debt instruments, and assets that you mark to market at least annually for federal income tax purposes. H&r block 2012 taxes However, see section 1. H&r block 2012 taxes 338-6(b)(2)(iii) of the regulations for exceptions that apply to debt instruments issued by persons related to a target corporation, contingent debt instruments, and debt instruments convertible into stock or other property. H&r block 2012 taxes Class IV assets are property of a kind that would properly be included in inventory if on hand at the end of the tax year or property held by the taxpayer primarily for sale to customers in the ordinary course of business. H&r block 2012 taxes Class V assets are all assets other than Class I, II, III, IV, VI, and VII assets. H&r block 2012 taxes    Note. H&r block 2012 taxes Furniture and fixtures, buildings, land, vehicles, and equipment, which constitute all or part of a trade or business are generally Class V assets. H&r block 2012 taxes Class VI assets are section 197 intangibles (other than goodwill and going concern value). H&r block 2012 taxes Class VII assets are goodwill and going concern value (whether the goodwill or going concern value qualifies as a section 197 intangible). H&r block 2012 taxes   If an asset described in one of the classifications described above can be included in more than one class, include it in the lower numbered class. H&r block 2012 taxes For example, if an asset is described in both Class II and Class IV, choose Class II. H&r block 2012 taxes Example. H&r block 2012 taxes The total paid in the sale of the assets of Company SKB is $21,000. H&r block 2012 taxes No cash or deposit accounts or similar accounts were sold. H&r block 2012 taxes The company's U. H&r block 2012 taxes S. H&r block 2012 taxes Government securities sold had a fair market value of $3,200. H&r block 2012 taxes The only other asset transferred (other than goodwill and going concern value) was inventory with a fair market value of $15,000. H&r block 2012 taxes Of the $21,000 paid for the assets of Company SKB, $3,200 is allocated to U. H&r block 2012 taxes S. H&r block 2012 taxes Government securities, $15,000 to inventory assets, and the remaining $2,800 to goodwill and going concern value. H&r block 2012 taxes Agreement. H&r block 2012 taxes   The buyer and seller may enter into a written agreement as to the allocation of any consideration or the fair market value of any of the assets. H&r block 2012 taxes This agreement is binding on both parties unless the IRS determines the amounts are not appropriate. H&r block 2012 taxes Reporting requirement. H&r block 2012 taxes   Both the buyer and seller involved in the sale of business assets must report to the IRS the allocation of the sales price among section 197 intangibles and the other business assets. H&r block 2012 taxes Use Form 8594, Asset Acquisition Statement Under Section 1060, to provide this information. H&r block 2012 taxes Generally, the buyer and seller should each attach Form 8594 to their federal income tax return for the year in which the sale occurred. H&r block 2012 taxes See the Instructions for Form 8594. H&r block 2012 taxes Dispositions of Intangible Property Intangible property is any personal property that has value but cannot be seen or touched. H&r block 2012 taxes It includes such items as patents, copyrights, and the goodwill value of a business. H&r block 2012 taxes Gain or loss on the sale or exchange of amortizable or depreciable intangible property held longer than 1 year (other than an amount recaptured as ordinary income) is a section 1231 gain or loss. H&r block 2012 taxes The treatment of section 1231 gain or loss and the recapture of amortization and depreciation as ordinary income are explained in chapter 3. H&r block 2012 taxes See chapter 8 of Publication 535, Business Expenses, for information on amortizable intangible property and chapter 1 of Publication 946, How To Depreciate Property, for information on intangible property that can and cannot be depreciated. H&r block 2012 taxes Gain or loss on dispositions of other intangible property is ordinary or capital depending on whether the property is a capital asset or a noncapital asset. H&r block 2012 taxes The following discussions explain special rules that apply to certain dispositions of intangible property. H&r block 2012 taxes Section 197 Intangibles Section 197 intangibles are certain intangible assets acquired after August 10, 1993 (after July 25, 1991, if chosen), and held in connection with the conduct of a trade or business or an activity entered into for profit whose costs are amortized over 15 years. H&r block 2012 taxes They include the following assets. H&r block 2012 taxes Goodwill. H&r block 2012 taxes Going concern value. H&r block 2012 taxes Workforce in place. H&r block 2012 taxes Business books and records, operating systems, and other information bases. H&r block 2012 taxes Patents, copyrights, formulas, processes, designs, patterns, know how, formats, and similar items. H&r block 2012 taxes Customer-based intangibles. H&r block 2012 taxes Supplier-based intangibles. H&r block 2012 taxes Licenses, permits, and other rights granted by a governmental unit. H&r block 2012 taxes Covenants not to compete entered into in connection with the acquisition of a business. H&r block 2012 taxes Franchises, trademarks, and trade names. H&r block 2012 taxes See chapter 8 of Publication 535 for a description of each intangible. H&r block 2012 taxes Dispositions. H&r block 2012 taxes   You cannot deduct a loss from the disposition or worthlessness of a section 197 intangible you acquired in the same transaction (or series of related transactions) as another section 197 intangible you still hold. H&r block 2012 taxes Instead, you must increase the adjusted basis of your retained section 197 intangible by the nondeductible loss. H&r block 2012 taxes If you retain more than one section 197 intangible, increase each intangible's adjusted basis. H&r block 2012 taxes Figure the increase by multiplying the nondeductible loss by a fraction, the numerator (top number) of which is the retained intangible's adjusted basis on the date of the loss and the denominator (bottom number) of which is the total adjusted basis of all retained intangibles on the date of the loss. H&r block 2012 taxes   In applying this rule, members of the same controlled group of corporations and commonly controlled businesses are treated as a single entity. H&r block 2012 taxes For example, a corporation cannot deduct a loss on the sale of a section 197 intangible if, after the sale, a member of the same controlled group retains other section 197 intangibles acquired in the same transaction as the intangible sold. H&r block 2012 taxes Covenant not to compete. H&r block 2012 taxes   A covenant not to compete (or similar arrangement) that is a section 197 intangible cannot be treated as disposed of or worthless before you have disposed of your entire interest in the trade or business for which the covenant was entered into. H&r block 2012 taxes Members of the same controlled group of corporations and commonly controlled businesses are treated as a single entity in determining whether a member has disposed of its entire interest in a trade or business. H&r block 2012 taxes Anti-churning rules. H&r block 2012 taxes   Anti-churning rules prevent a taxpayer from converting section 197 intangibles that do not qualify for amortization into property that would qualify for amortization. H&r block 2012 taxes However, these rules do not apply to part of the basis of property acquired by certain related persons if the transferor elects to do both the following. H&r block 2012 taxes Recognize gain on the transfer of the property. H&r block 2012 taxes Pay income tax on the gain at the highest tax rate. H&r block 2012 taxes   If the transferor is a partnership or S corporation, the partnership or S corporation (not the partners or shareholders) can make the election. H&r block 2012 taxes But each partner or shareholder must pay the tax on his or her share of gain. H&r block 2012 taxes   To make the election, you, as the transferor, must attach a statement containing certain information to your income tax return for the year of the transfer. H&r block 2012 taxes You must file the tax return by the due date (including extensions). H&r block 2012 taxes You must also notify the transferee of the election in writing by the due date of the return. H&r block 2012 taxes   If you timely filed your return without making the election, you can make the election by filing an amended return within 6 months after the due date of the return (excluding extensions). H&r block 2012 taxes Attach the statement to the amended return and write “Filed pursuant to section 301. H&r block 2012 taxes 9100-2” at the top of the statement. H&r block 2012 taxes File the amended return at the same address the original return was filed. H&r block 2012 taxes For more information about making the election, see Regulations section 1. H&r block 2012 taxes 197-2(h)(9). H&r block 2012 taxes For information about reporting the tax on your income tax return, see the Instructions for Form 4797. H&r block 2012 taxes Patents The transfer of a patent by an individual is treated as a sale or exchange of a capital asset held longer than 1 year. H&r block 2012 taxes This applies even if the payments for the patent are made periodically during the transferee's use or are contingent on the productivity, use, or disposition of the patent. H&r block 2012 taxes For information on the treatment of gain or loss on the transfer of capital assets, see chapter 4. H&r block 2012 taxes This treatment applies to your transfer of a patent if you meet all the following conditions. H&r block 2012 taxes You are the holder of the patent. H&r block 2012 taxes You transfer the patent other than by gift, inheritance, or devise. H&r block 2012 taxes You transfer all substantial rights to the patent or an undivided interest in all such rights. H&r block 2012 taxes You do not transfer the patent to a related person. H&r block 2012 taxes Holder. H&r block 2012 taxes   You are the holder of a patent if you are either of the following. H&r block 2012 taxes The individual whose effort created the patent property and who qualifies as the original and first inventor. H&r block 2012 taxes The individual who bought an interest in the patent from the inventor before the invention was tested and operated successfully under operating conditions and who is neither related to, nor the employer of, the inventor. H&r block 2012 taxes All substantial rights. H&r block 2012 taxes   All substantial rights to patent property are all rights that have value when they are transferred. H&r block 2012 taxes A security interest (such as a lien), or a reservation calling for forfeiture for nonperformance, is not treated as a substantial right for these rules and may be kept by you as the holder of the patent. H&r block 2012 taxes   All substantial rights to a patent are not transferred if any of the following apply to the transfer. H&r block 2012 taxes The rights are limited geographically within a country. H&r block 2012 taxes The rights are limited to a period less than the remaining life of the patent. H&r block 2012 taxes The rights are limited to fields of use within trades or industries and are less than all the rights that exist and have value at the time of the transfer. H&r block 2012 taxes The rights are less than all the claims or inventions covered by the patent that exist and have value at the time of the transfer. H&r block 2012 taxes Related persons. H&r block 2012 taxes   This tax treatment does not apply if the transfer is directly or indirectly between you and a related person as defined earlier in the list under Nondeductible Loss, with the following changes. H&r block 2012 taxes Members of your family include your spouse, ancestors, and lineal descendants, but not your brothers, sisters, half-brothers, or half-sisters. H&r block 2012 taxes Substitute “25% or more” ownership for “more than 50%. H&r block 2012 taxes ”   If you fit within the definition of a related person independent of family status, the brother-sister exception in (1), earlier, does not apply. H&r block 2012 taxes For example, a transfer between a brother and a sister as beneficiary and fiduciary of the same trust is a transfer between related persons. H&r block 2012 taxes The brother-sister exception does not apply because the trust relationship is independent of family status. H&r block 2012 taxes Franchise, Trademark, or Trade Name If you transfer or renew a franchise, trademark, or trade name for a price contingent on its productivity, use, or disposition, the amount you receive generally is treated as an amount realized from the sale of a noncapital asset. H&r block 2012 taxes A franchise includes an agreement that gives one of the parties the right to distribute, sell, or provide goods, services, or facilities within a specified area. H&r block 2012 taxes Significant power, right, or continuing interest. H&r block 2012 taxes   If you keep any significant power, right, or continuing interest in the subject matter of a franchise, trademark, or trade name that you transfer or renew, the amount you receive is ordinary royalty income rather than an amount realized from a sale or exchange. H&r block 2012 taxes   A significant power, right, or continuing interest in a franchise, trademark, or trade name includes, but is not limited to, the following rights in the transferred interest. H&r block 2012 taxes A right to disapprove any assignment of the interest, or any part of it. H&r block 2012 taxes A right to end the agreement at will. H&r block 2012 taxes A right to set standards of quality for products used or sold, or for services provided, and for the equipment and facilities used to promote such products or services. H&r block 2012 taxes A right to make the recipient sell or advertise only your products or services. H&r block 2012 taxes A right to make the recipient buy most supplies and equipment from you. H&r block 2012 taxes A right to receive payments based on the productivity, use, or disposition of the transferred item of interest if those payments are a substantial part of the transfer agreement. H&r block 2012 taxes Subdivision of Land If you own a tract of land and, to sell or exchange it, you subdivide it into individual lots or parcels, the gain normally is ordinary income. H&r block 2012 taxes However, you may receive capital gain treatment on at least part of the proceeds provided you meet certain requirements. H&r block 2012 taxes See section 1237 of the Internal Revenue Code. H&r block 2012 taxes Timber Standing timber held as investment property is a capital asset. H&r block 2012 taxes Gain or loss from its sale is reported as a capital gain or loss on Form 8949, and Schedule D (Form 1040), as applicable. H&r block 2012 taxes If you held the timber primarily for sale to customers, it is not a capital asset. H&r block 2012 taxes Gain or loss on its sale is ordinary business income or loss. H&r block 2012 taxes It is reported in the gross receipts or sales and cost of goods sold items of your return. H&r block 2012 taxes Farmers who cut timber on their land and sell it as logs, firewood, or pulpwood usually have no cost or other basis for that timber. H&r block 2012 taxes These sales constitute a very minor part of their farm businesses. H&r block 2012 taxes In these cases, amounts realized from such sales, and the expenses of cutting, hauling, etc. H&r block 2012 taxes , are ordinary farm income and expenses reported on Schedule F (Form 1040), Profit or Loss From Farming. H&r block 2012 taxes Different rules apply if you owned the timber longer than 1 year and elect to either: Treat timber cutting as a sale or exchange, or Enter into a cutting contract. H&r block 2012 taxes Timber is considered cut on the date when, in the ordinary course of business, the quantity of felled timber is first definitely determined. H&r block 2012 taxes This is true whether the timber is cut under contract or whether you cut it yourself. H&r block 2012 taxes Under the rules discussed below, disposition of the timber is treated as a section 1231 transaction. H&r block 2012 taxes See chapter 3. H&r block 2012 taxes Gain or loss is reported on Form 4797. H&r block 2012 taxes Christmas trees. H&r block 2012 taxes   Evergreen trees, such as Christmas trees, that are more than 6 years old when severed from their roots and sold for ornamental purposes are included in the term timber. H&r block 2012 taxes They qualify for both rules discussed below. H&r block 2012 taxes Election to treat cutting as a sale or exchange. H&r block 2012 taxes   Under the general rule, the cutting of timber results in no gain or loss. H&r block 2012 taxes It is not until a sale or exchange occurs that gain or loss is realized. H&r block 2012 taxes But if you owned or had a contractual right to cut timber, you can elect to treat the cutting of timber as a section 1231 transaction in the year the timber is cut. H&r block 2012 taxes Even though the cut timber is not actually sold or exchanged, you report your gain or loss on the cutting for the year the timber is cut. H&r block 2012 taxes Any later sale results in ordinary business income or loss. H&r block 2012 taxes See Example, later. H&r block 2012 taxes   To elect this treatment, you must: Own or hold a contractual right to cut the timber for a period of more than 1 year before it is cut, and Cut the timber for sale or for use in your trade or business. H&r block 2012 taxes Making the election. H&r block 2012 taxes   You make the election on your return for the year the cutting takes place by including in income the gain or loss on the cutting and including a computation of the gain or loss. H&r block 2012 taxes You do not have to make the election in the first year you cut timber. H&r block 2012 taxes You can make it in any year to which the election would apply. H&r block 2012 taxes If the timber is partnership property, the election is made on the partnership return. H&r block 2012 taxes This election cannot be made on an amended return. H&r block 2012 taxes   Once you have made the election, it remains in effect for all later years unless you cancel it. H&r block 2012 taxes   If you previously elected to treat the cutting of timber as a sale or exchange, you may revoke this election without the consent of the IRS. H&r block 2012 taxes The prior election (and revocation) is disregarded for purposes of making a subsequent election. H&r block 2012 taxes See Form T (Timber), Forest Activities Schedule, for more information. H&r block 2012 taxes Gain or loss. H&r block 2012 taxes   Your gain or loss on the cutting of standing timber is the difference between its adjusted basis for depletion and its fair market value on the first day of your tax year in which it is cut. H&r block 2012 taxes   Your adjusted basis for depletion of cut timber is based on the number of units (feet board measure, log scale, or other units) of timber cut during the tax year and considered to be sold or exchanged. H&r block 2012 taxes Your adjusted basis for depletion is also based on the depletion unit of timber in the account used for the cut timber, and should be figured in the same manner as shown in section 611 of the Internal Revenue Code and the related regulations. H&r block 2012 taxes   Timber depletion is discussed in chapter 9 of Publication 535. H&r block 2012 taxes Example. H&r block 2012 taxes In April 2013, you had owned 4,000 MBF (1,000 board feet) of standing timber longer than 1 year. H&r block 2012 taxes It had an adjusted basis for depletion of $40 per MBF. H&r block 2012 taxes You are a calendar year taxpayer. H&r block 2012 taxes On January 1, 2013, the timber had a fair market value (FMV) of $350 per MBF. H&r block 2012 taxes It was cut in April for sale. H&r block 2012 taxes On your 2013 tax return, you elect to treat the cutting of the timber as a sale or exchange. H&r block 2012 taxes You report the difference between the fair market value and your adjusted basis for depletion as a gain. H&r block 2012 taxes This amount is reported on Form 4797 along with your other section 1231 gains and losses to figure whether it is treated as capital gain or as ordinary gain. H&r block 2012 taxes You figure your gain as follows. H&r block 2012 taxes FMV of timber January 1, 2013 $1,400,000 Minus: Adjusted basis for depletion 160,000 Section 1231 gain $1,240,000 The fair market value becomes your basis in the cut timber and a later sale of the cut timber including any by-product or tree tops will result in ordinary business income or loss. H&r block 2012 taxes Outright sales of timber. H&r block 2012 taxes   Outright sales of timber by landowners qualify for capital gains treatment using rules similar to the rules for certain disposal of timber under a contract with retained economic interest (defined below). H&r block 2012 taxes However, for outright sales, the date of disposal is not deemed to be the date the timber is cut because the landowner can elect to treat the payment date as the date of disposal (see below). H&r block 2012 taxes Cutting contract. H&r block 2012 taxes   You must treat the disposal of standing timber under a cutting contract as a section 1231 transaction if all the following apply to you. H&r block 2012 taxes You are the owner of the timber. H&r block 2012 taxes You held the timber longer than 1 year before its disposal. H&r block 2012 taxes You kept an economic interest in the timber. H&r block 2012 taxes   You have kept an economic interest in standing timber if, under the cutting contract, the expected return on your investment is conditioned on the cutting of the timber. H&r block 2012 taxes   The difference between the amount realized from the disposal of the timber and its adjusted basis for depletion is treated as gain or loss on its sale. H&r block 2012 taxes Include this amount on Form 4797 along with your other section 1231 gains or losses to figure whether it is treated as capital or ordinary gain or loss. H&r block 2012 taxes Date of disposal. H&r block 2012 taxes   The date of disposal is the date the timber is cut. H&r block 2012 taxes However, for outright sales by landowners or if you receive payment under the contract before the timber is cut, you can elect to treat the date of payment as the date of disposal. H&r block 2012 taxes   This election applies only to figure the holding period of the timber. H&r block 2012 taxes It has no effect on the time for reporting gain or loss (generally when the timber is sold or exchanged). H&r block 2012 taxes   To make this election, attach a statement to the tax return filed by the due date (including extensions) for the year payment is received. H&r block 2012 taxes The statement must identify the advance payments subject to the election and the contract under which they were made. H&r block 2012 taxes   If you timely filed your return for the year you received payment without making the election, you still can make the election by filing an amended return within 6 months after the due date for that year's return (excluding extensions). H&r block 2012 taxes Attach the statement to the amended return and write “Filed pursuant to section 301. H&r block 2012 taxes 9100-2” at the top of the statement. H&r block 2012 taxes File the amended return at the same address the original return was filed. H&r block 2012 taxes Owner. H&r block 2012 taxes   The owner of timber is any person who owns an interest in it, including a sublessor and the holder of a contract to cut the timber. H&r block 2012 taxes You own an interest in timber if you have the right to cut it for sale on your own account or for use in your business. H&r block 2012 taxes Tree stumps. H&r block 2012 taxes   Tree stumps are a capital asset if they are on land held by an investor who is not in the timber or stump business as a buyer, seller, or processor. H&r block 2012 taxes Gain from the sale of stumps sold in one lot by such a holder is taxed as a capital gain. H&r block 2012 taxes However, tree stumps held by timber operators after the saleable standing timber was cut and removed from the land are considered by-products. H&r block 2012 taxes Gain from the sale of stumps in lots or tonnage by such operators is taxed as ordinary income. H&r block 2012 taxes   See Form T (Timber) and its separate instructions for more information about dispositions of timber. H&r block 2012 taxes Precious Metals and Stones, Stamps, and Coins Gold, silver, gems, stamps, coins, etc. H&r block 2012 taxes , are capital assets except when they are held for sale by a dealer. H&r block 2012 taxes Any gain or loss from their sale or exchange generally is a capital gain or loss. H&r block 2012 taxes If you are a dealer, the amount received from the sale is ordinary business income. H&r block 2012 taxes Coal and Iron Ore You must treat the disposal of coal (including lignite) or iron ore mined in the United States as a section 1231 transaction if both the following apply to you. H&r block 2012 taxes You owned the coal or iron ore longer than 1 year before its disposal. H&r block 2012 taxes You kept an economic interest in the coal or iron ore. H&r block 2012 taxes For this rule, the date the coal or iron ore is mined is considered the date of its disposal. H&r block 2012 taxes Your gain or loss is the difference between the amount realized from disposal of the coal or iron ore and the adjusted basis you use to figure cost depletion (increased by certain expenses not allowed as deductions for the tax year). H&r block 2012 taxes This amount is included on Form 4797 along with your other section 1231 gains and losses. H&r block 2012 taxes You are considered an owner if you own or sublet an economic interest in the coal or iron ore in place. H&r block 2012 taxes If you own only an option to buy the coal in place, you do not qualify as an owner. H&r block 2012 taxes In addition, this gain or loss treatment does not apply to income realized by an owner who is a co-adventurer, partner, or principal in the mining of coal or iron ore. H&r block 2012 taxes The expenses of making and administering the contract under which the coal or iron ore was disposed of and the expenses of preserving the economic interest kept under the contract are not allowed as deductions in figuring taxable income. H&r block 2012 taxes Rather, their total, along with the adjusted depletion basis, is deducted from the amount received to determine gain. H&r block 2012 taxes If the total of these expenses plus the adjusted depletion basis is more than the amount received, the result is a loss. H&r block 2012 taxes Special rule. H&r block 2012 taxes   The above treatment does not apply if you directly or indirectly dispose of the iron ore or coal to any of the following persons. H&r block 2012 taxes A related person whose relationship to you would result in the disallowance of a loss (see Nondeductible Loss under Sales and Exchanges Between Related Persons, earlier). H&r block 2012 taxes An individual, trust, estate, partnership, association, company, or corporation owned or controlled directly or indirectly by the same interests that own or control your business. H&r block 2012 taxes Conversion Transactions Recognized gain on the disposition or termination of any position held as part of certain conversion transactions is treated as ordinary income. H&r block 2012 taxes This applies if substantially all your expected return is attributable to the time value of your net investment (like interest on a loan) and the transaction is any of the following. H&r block 2012 taxes An applicable straddle (generally, any set of offsetting positions with respect to personal property, including stock). H&r block 2012 taxes A transaction in which you acquire property and, at or about the same time, you contract to sell the same or substantially identical property at a specified price. H&r block 2012 taxes Any other transaction that is marketed and sold as producing capital gain from a transaction in which substantially all of your expected return is due to the time value of your net investment. H&r block 2012 taxes For more information, see chapter 4 of Publication 550. H&r block 2012 taxes Prev  Up  Next   Home   More Online Publications
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The H&r Block 2012 Taxes

H&r block 2012 taxes 4. H&r block 2012 taxes   Interest Table of Contents Introduction Topics - This chapter discusses: Useful Items - You may want to see: Allocation of InterestOrder of funds spent. H&r block 2012 taxes Payments from checking accounts. H&r block 2012 taxes Amounts paid within 30 days. H&r block 2012 taxes Optional method for determining date of reallocation. H&r block 2012 taxes Interest on a segregated account. H&r block 2012 taxes How to report. H&r block 2012 taxes Interest You Can DeductStatement. H&r block 2012 taxes Expenses paid to obtain a mortgage. H&r block 2012 taxes Prepayment penalty. H&r block 2012 taxes De minimis OID. H&r block 2012 taxes Constant-yield method. H&r block 2012 taxes Loan or mortgage ends. H&r block 2012 taxes Interest You Cannot DeductPenalties. H&r block 2012 taxes Who is a key person? Exceptions for pre-June 1997 contracts. H&r block 2012 taxes Interest allocated to unborrowed policy cash value. H&r block 2012 taxes Capitalization of Interest When To Deduct InterestPrepaid interest. H&r block 2012 taxes Discounted loan. H&r block 2012 taxes Refunds of interest. H&r block 2012 taxes Prepaid interest. H&r block 2012 taxes Discounted loan. H&r block 2012 taxes Tax deficiency. H&r block 2012 taxes Related person. H&r block 2012 taxes Below-Market LoansLimit on forgone interest for gift loans of $100,000 or less. H&r block 2012 taxes Introduction This chapter discusses the tax treatment of business interest expense. H&r block 2012 taxes Business interest expense is an amount charged for the use of money you borrowed for business activities. H&r block 2012 taxes 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. H&r block 2012 taxes Sch K-1 (Form 1120S) Shareholder's Share of Income, Deductions, Credits, etc. H&r block 2012 taxes 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. H&r block 2012 taxes Allocation of Interest The rules for deducting interest vary, depending on whether the loan proceeds are used for business, personal, or investment activities. H&r block 2012 taxes 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. H&r block 2012 taxes Allocate your interest expense to the following categories. H&r block 2012 taxes 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. H&r block 2012 taxes You allocate loan proceeds by tracing disbursements to specific uses. H&r block 2012 taxes The easiest way to trace disbursements to specific uses is to keep the proceeds of a particular loan separate from any other funds. H&r block 2012 taxes Secured loan. H&r block 2012 taxes   The allocation of loan proceeds and the related interest is not generally affected by the use of property that secures the loan. H&r block 2012 taxes Example. H&r block 2012 taxes You secure a loan with property used in your business. H&r block 2012 taxes You use the loan proceeds to buy an automobile for personal use. H&r block 2012 taxes You must allocate interest expense on the loan to personal use (purchase of the automobile) even though the loan is secured by business property. H&r block 2012 taxes    If the property that secures the loan is your home, you generally do not allocate the loan proceeds or the related interest. H&r block 2012 taxes The interest is usually deductible as qualified home mortgage interest, regardless of how the loan proceeds are used. H&r block 2012 taxes For more information, see Publication 936. H&r block 2012 taxes Allocation period. H&r block 2012 taxes   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. H&r block 2012 taxes The date the loan is repaid. H&r block 2012 taxes The date the loan is reallocated to another use. H&r block 2012 taxes Proceeds not disbursed to borrower. H&r block 2012 taxes   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. H&r block 2012 taxes This applies whether you pay for property, services, or anything else by incurring a loan, or you take property subject to a debt. H&r block 2012 taxes Proceeds deposited in borrower's account. H&r block 2012 taxes   Treat loan proceeds deposited in an account as property held for investment. H&r block 2012 taxes It does not matter whether the account pays interest. H&r block 2012 taxes Any interest you pay on the loan is investment interest expense. H&r block 2012 taxes If you withdraw the proceeds of the loan, you must reallocate the loan based on the use of the funds. H&r block 2012 taxes Example. H&r block 2012 taxes Celina, a calendar-year taxpayer, borrows $100,000 on January 4 and immediately uses the proceeds to open a checking account. H&r block 2012 taxes No other amounts are deposited in the account during the year and no part of the loan principal is repaid during the year. H&r block 2012 taxes On April 2, Celina uses $20,000 from the checking account for a passive activity expenditure. H&r block 2012 taxes On September 4, Celina uses an additional $40,000 from the account for personal purposes. H&r block 2012 taxes 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. H&r block 2012 taxes 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. H&r block 2012 taxes 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. H&r block 2012 taxes Order of funds spent. H&r block 2012 taxes   Generally, you treat loan proceeds deposited in an account as used (spent) before either of the following amounts. H&r block 2012 taxes Any unborrowed amounts held in the same account. H&r block 2012 taxes Any amounts deposited after these loan proceeds. H&r block 2012 taxes Example. H&r block 2012 taxes On January 9, Olena opened a checking account, depositing $500 of the proceeds of Loan A and $1,000 of unborrowed funds. H&r block 2012 taxes The following table shows the transactions in her account during the tax year. H&r block 2012 taxes 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. H&r block 2012 taxes She treats the $700 used for a passive activity as made from the remaining $200 proceeds of Loan B and $500 of unborrowed funds. H&r block 2012 taxes She treats the $800 used for an investment as made entirely from the proceeds of Loan C. H&r block 2012 taxes She treats the $600 used for personal purposes as made from the remaining $200 proceeds of Loan C and $400 of unborrowed funds. H&r block 2012 taxes For the periods during which loan proceeds are held in the account, Olena treats them as property held for investment. H&r block 2012 taxes Payments from checking accounts. H&r block 2012 taxes   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. H&r block 2012 taxes You can treat checks written on the same day as written in any order. H&r block 2012 taxes Amounts paid within 30 days. H&r block 2012 taxes   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. H&r block 2012 taxes This applies to any payment made within 30 days before or after the proceeds are received in cash or deposited in your account. H&r block 2012 taxes   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. H&r block 2012 taxes 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. H&r block 2012 taxes   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. H&r block 2012 taxes Example. H&r block 2012 taxes Giovanni gets a loan of $1,000 on August 4 and receives the proceeds in cash. H&r block 2012 taxes 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. H&r block 2012 taxes Also, Giovanni deposits his paycheck, deposits other loan proceeds, and pays his bills during the same period. H&r block 2012 taxes 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. H&r block 2012 taxes 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. H&r block 2012 taxes Optional method for determining date of reallocation. H&r block 2012 taxes   You can use the following method to determine the date loan proceeds are reallocated to another use. H&r block 2012 taxes You can treat all payments from loan proceeds in the account during any month as taking place on the later of the following dates. H&r block 2012 taxes The first day of that month. H&r block 2012 taxes The date the loan proceeds are deposited in the account. H&r block 2012 taxes 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. H&r block 2012 taxes Interest on a segregated account. H&r block 2012 taxes   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. H&r block 2012 taxes When the interest earned is used up, any remaining payments are from loan proceeds. H&r block 2012 taxes Example. H&r block 2012 taxes You borrowed $20,000 and used the proceeds of this loan to open a new savings account. H&r block 2012 taxes When the account had earned interest of $867, you withdrew $20,000 for personal purposes. H&r block 2012 taxes 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). H&r block 2012 taxes 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. H&r block 2012 taxes 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. H&r block 2012 taxes 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. H&r block 2012 taxes Loan repayment. H&r block 2012 taxes   When you repay any part of a loan allocated to more than one use, treat it as being repaid in the following order. H&r block 2012 taxes Personal use. H&r block 2012 taxes Investments and passive activities (other than those included in (3)). H&r block 2012 taxes Passive activities in connection with a rental real estate activity in which you actively participate. H&r block 2012 taxes Former passive activities. H&r block 2012 taxes Trade or business use and expenses for certain low-income housing projects. H&r block 2012 taxes Line of credit (continuous borrowings). H&r block 2012 taxes   The following rules apply if you have a line of credit or similar arrangement. H&r block 2012 taxes Treat all borrowed funds on which interest accrues at the same fixed or variable rate as a single loan. H&r block 2012 taxes Treat borrowed funds or parts of borrowed funds on which interest accrues at different fixed or variable rates as different loans. H&r block 2012 taxes Treat these loans as repaid in the order shown on the loan agreement. H&r block 2012 taxes Loan refinancing. H&r block 2012 taxes   Allocate the replacement loan to the same uses to which the repaid loan was allocated. H&r block 2012 taxes Make the allocation only to the extent you use the proceeds of the new loan to repay any part of the original loan. H&r block 2012 taxes Debt-financed distribution. H&r block 2012 taxes   A debt-financed distribution occurs when a partnership or S corporation borrows funds and allocates those funds to distributions made to partners or shareholders. H&r block 2012 taxes The manner in which you report the interest expense associated with the distributed debt proceeds depends on your use of those proceeds. H&r block 2012 taxes How to report. H&r block 2012 taxes   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). H&r block 2012 taxes 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). H&r block 2012 taxes If the proceeds were used in an investment activity, enter the interest on Form 4952. H&r block 2012 taxes If the proceeds are used for personal purposes, the interest is generally not deductible. H&r block 2012 taxes 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. H&r block 2012 taxes Interest relates to your trade or business if you use the proceeds of the loan for a trade or business expense. H&r block 2012 taxes It does not matter what type of property secures the loan. H&r block 2012 taxes You can deduct interest on a debt only if you meet all the following requirements. H&r block 2012 taxes You are legally liable for that debt. H&r block 2012 taxes Both you and the lender intend that the debt be repaid. H&r block 2012 taxes You and the lender have a true debtor-creditor relationship. H&r block 2012 taxes Partial liability. H&r block 2012 taxes   If you are liable for part of a business debt, you can deduct only your share of the total interest paid or accrued. H&r block 2012 taxes Example. H&r block 2012 taxes You and your brother borrow money. H&r block 2012 taxes You are liable for 50% of the note. H&r block 2012 taxes You use your half of the loan in your business, and you make one-half of the loan payments. H&r block 2012 taxes You can deduct your half of the total interest payments as a business deduction. H&r block 2012 taxes Mortgage. H&r block 2012 taxes   Generally, mortgage interest paid or accrued on real estate you own legally or equitably is deductible. H&r block 2012 taxes 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. H&r block 2012 taxes Statement. H&r block 2012 taxes   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. H&r block 2012 taxes 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. H&r block 2012 taxes A governmental unit is a person for purposes of furnishing the statement. H&r block 2012 taxes   If you receive a refund of interest you overpaid in an earlier year, this amount will be reported in box 3 of Form 1098. H&r block 2012 taxes You cannot deduct this amount. H&r block 2012 taxes For information on how to report this refund, see Refunds of interest, later in this chapter. H&r block 2012 taxes Expenses paid to obtain a mortgage. H&r block 2012 taxes   Certain expenses you pay to obtain a mortgage cannot be deducted as interest. H&r block 2012 taxes These expenses, which include mortgage commissions, abstract fees, and recording fees, are capital expenses. H&r block 2012 taxes If the property mortgaged is business or income-producing property, you can amortize the costs over the life of the mortgage. H&r block 2012 taxes Prepayment penalty. H&r block 2012 taxes   If you pay off your mortgage early and pay the lender a penalty for doing this, you can deduct the penalty as interest. H&r block 2012 taxes Interest on employment tax deficiency. H&r block 2012 taxes   Interest charged on employment taxes assessed on your business is deductible. H&r block 2012 taxes Original issue discount (OID). H&r block 2012 taxes   OID is a form of interest. H&r block 2012 taxes A loan (mortgage or other debt) generally has OID when its proceeds are less than its principal amount. H&r block 2012 taxes The OID is the difference between the stated redemption price at maturity and the issue price of the loan. H&r block 2012 taxes   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. H&r block 2012 taxes 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. H&r block 2012 taxes You generally deduct OID over the term of the loan. H&r block 2012 taxes Figure the amount to deduct each year using the constant-yield method, unless the OID on the loan is de minimis. H&r block 2012 taxes De minimis OID. H&r block 2012 taxes   The OID is de minimis if it is less than one-fourth of 1% (. H&r block 2012 taxes 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). H&r block 2012 taxes   If the OID is de minimis, you can choose one of the following ways to figure the amount you can deduct each year. H&r block 2012 taxes On a constant-yield basis over the term of the loan. H&r block 2012 taxes On a straight-line basis over the term of the loan. H&r block 2012 taxes In proportion to stated interest payments. H&r block 2012 taxes In its entirety at maturity of the loan. H&r block 2012 taxes 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. H&r block 2012 taxes Example. H&r block 2012 taxes On January 1, 2013, you took out a $100,000 discounted loan and received $98,500 in proceeds. H&r block 2012 taxes The loan will mature on January 1, 2023 (a 10-year term), and the $100,000 principal is payable on that date. H&r block 2012 taxes Interest of $10,000 is payable on January 1 of each year, beginning January 1, 2014. H&r block 2012 taxes The $1,500 OID on the loan is de minimis because it is less than $2,500 ($100,000 × . H&r block 2012 taxes 0025 × 10). H&r block 2012 taxes You choose to deduct the OID on a straight-line basis over the term of the loan. H&r block 2012 taxes Beginning in 2013, you can deduct $150 each year for 10 years. H&r block 2012 taxes Constant-yield method. H&r block 2012 taxes   If the OID is not de minimis, you must use the constant-yield method to figure how much you can deduct each year. H&r block 2012 taxes You figure your deduction for the first year using the following steps. H&r block 2012 taxes Determine the issue price of the loan. H&r block 2012 taxes Generally, this equals the proceeds of the loan. H&r block 2012 taxes If you paid points on the loan (as discussed later), the issue price generally is the difference between the proceeds and the points. H&r block 2012 taxes Multiply the result in (1) by the yield to maturity. H&r block 2012 taxes Subtract any qualified stated interest payments from the result in (2). H&r block 2012 taxes This is the OID you can deduct in the first year. H&r block 2012 taxes   To figure your deduction in any subsequent year, follow the above steps, except determine the adjusted issue price in step (1). H&r block 2012 taxes To get the adjusted issue price, add to the issue price any OID previously deducted. H&r block 2012 taxes Then follow steps (2) and (3) above. H&r block 2012 taxes   The yield to maturity is generally shown in the literature you receive from your lender. H&r block 2012 taxes If you do not have this information, consult your lender or tax advisor. H&r block 2012 taxes 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. H&r block 2012 taxes Example. H&r block 2012 taxes 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. H&r block 2012 taxes The yield to maturity on your loan is 10. H&r block 2012 taxes 2467%, compounded annually. H&r block 2012 taxes For 2013, you can deduct $93 [($98,500 × . H&r block 2012 taxes 102467) − $10,000]. H&r block 2012 taxes For 2014, you can deduct $103 [($98,593 × . H&r block 2012 taxes 102467) − $10,000]. H&r block 2012 taxes Loan or mortgage ends. H&r block 2012 taxes   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. H&r block 2012 taxes A loan or mortgage may end due to a refinancing, prepayment, foreclosure, or similar event. H&r block 2012 taxes 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. H&r block 2012 taxes See Interest paid with funds borrowed from original lender under Interest You Cannot Deduct, later. H&r block 2012 taxes Points. H&r block 2012 taxes   The term “points” is used to describe certain charges paid, or treated as paid, by a borrower to obtain a loan or a mortgage. H&r block 2012 taxes These charges are also called loan origination fees, maximum loan charges, discount points, or premium charges. H&r block 2012 taxes If any of these charges (points) are solely for the use of money, they are interest. H&r block 2012 taxes   Because points are prepaid interest, you generally cannot deduct the full amount in the year paid. H&r block 2012 taxes However, you can choose to fully deduct points in the year paid if you meet certain tests. H&r block 2012 taxes For exceptions to the general rule, see Publication 936. H&r block 2012 taxes The points reduce the issue price of the loan and result in original issue discount (OID), deductible as explained in the preceding discussion. H&r block 2012 taxes Partial payments on a nontax debt. H&r block 2012 taxes   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. H&r block 2012 taxes You can deduct only the interest. H&r block 2012 taxes 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. H&r block 2012 taxes Installment purchase. H&r block 2012 taxes   If you make an installment purchase of business property, the contract between you and the seller generally provides for the payment of interest. H&r block 2012 taxes 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). H&r block 2012 taxes The amount recharacterized as interest reduces your basis in the property and increases your interest expense. H&r block 2012 taxes For more information on installment sales and unstated interest, see Publication 537. H&r block 2012 taxes Interest You Cannot Deduct Certain interest payments cannot be deducted. H&r block 2012 taxes In addition, certain other expenses that may seem to be interest but are not, cannot be deducted as interest. H&r block 2012 taxes You cannot currently deduct interest that must be capitalized, and you generally cannot deduct personal interest. H&r block 2012 taxes Interest paid with funds borrowed from original lender. H&r block 2012 taxes   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. H&r block 2012 taxes You can deduct the interest expense once you start making payments on the new loan. H&r block 2012 taxes   When you make a payment on the new loan, you first apply the payment to interest and then to the principal. H&r block 2012 taxes 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. H&r block 2012 taxes Capitalized interest. H&r block 2012 taxes   You cannot currently deduct interest you are required to capitalize under the uniform capitalization rules. H&r block 2012 taxes See Capitalization of Interest, later. H&r block 2012 taxes 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. H&r block 2012 taxes Add this interest to the basis of the property. H&r block 2012 taxes Commitment fees or standby charges. H&r block 2012 taxes   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. H&r block 2012 taxes You may be able to deduct them as business expenses. H&r block 2012 taxes   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. H&r block 2012 taxes See Capitalization of Interest, later. H&r block 2012 taxes Interest on income tax. H&r block 2012 taxes   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. H&r block 2012 taxes Treat this interest as a business deduction only in figuring a net operating loss deduction. H&r block 2012 taxes Penalties. H&r block 2012 taxes   Penalties on underpaid deficiencies and underpaid estimated tax are not interest. H&r block 2012 taxes You cannot deduct them. H&r block 2012 taxes Generally, you cannot deduct any fines or penalties. H&r block 2012 taxes Interest on loans with respect to life insurance policies. H&r block 2012 taxes   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. H&r block 2012 taxes   If the policy or contract covers a key person, you can deduct the interest on up to $50,000 of debt for that person. H&r block 2012 taxes 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. H&r block 2012 taxes Who is a key person?   A key person is an officer or 20% owner. H&r block 2012 taxes However, the number of individuals you can treat as key persons is limited to the greater of the following. H&r block 2012 taxes Five individuals. H&r block 2012 taxes The lesser of 5% of the total officers and employees of the company or 20 individuals. H&r block 2012 taxes Exceptions for pre-June 1997 contracts. H&r block 2012 taxes   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. H&r block 2012 taxes If the contract was purchased before June 21, 1986, you can generally deduct the interest no matter who is covered by the contract. H&r block 2012 taxes Interest allocated to unborrowed policy cash value. H&r block 2012 taxes   Corporations and partnerships generally cannot deduct any interest expense allocable to unborrowed cash values of life insurance, annuity, or endowment contracts. H&r block 2012 taxes This rule applies to contracts issued after June 8, 1997, that cover someone other than an officer, director, employee, or 20% owner. H&r block 2012 taxes For more information, see section 264(f) of the Internal Revenue Code. H&r block 2012 taxes 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. H&r block 2012 taxes The property must be produced by you for use in your trade or business or for sale to customers. H&r block 2012 taxes You cannot capitalize interest related to property that you acquire in any other manner. H&r block 2012 taxes Interest you paid or incurred during the production period must be capitalized if the property produced is designated property. H&r block 2012 taxes Designated property is any of the following. H&r block 2012 taxes Real property. H&r block 2012 taxes Tangible personal property with a class life of 20 years or more. H&r block 2012 taxes Tangible personal property with an estimated production period of more than 2 years. H&r block 2012 taxes Tangible personal property with an estimated production period of more than 1 year if the estimated cost of production is more than $1 million. H&r block 2012 taxes Property you produce. H&r block 2012 taxes   You produce property if you construct, build, install, manufacture, develop, improve, create, raise, or grow it. H&r block 2012 taxes Treat property produced for you under a contract as produced by you up to the amount you pay or incur for the property. H&r block 2012 taxes Carrying charges. H&r block 2012 taxes   Carrying charges include taxes you pay to carry or develop real estate or to carry, transport, or install personal property. H&r block 2012 taxes You can choose to capitalize carrying charges not subject to the uniform capitalization rules if they are otherwise deductible. H&r block 2012 taxes For more information, see chapter 7. H&r block 2012 taxes Capitalized interest. H&r block 2012 taxes   Treat capitalized interest as a cost of the property produced. H&r block 2012 taxes You recover your interest when you sell or use the property. H&r block 2012 taxes If the property is inventory, recover capitalized interest through cost of goods sold. H&r block 2012 taxes If the property is used in your trade or business, recover capitalized interest through an adjustment to basis, depreciation, amortization, or other method. H&r block 2012 taxes Partnerships and S corporations. H&r block 2012 taxes   The interest capitalization rules are applied first at the partnership or S corporation level. H&r block 2012 taxes 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. H&r block 2012 taxes   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. H&r block 2012 taxes You may also have to capitalize interest incurred by the partnership or S corporation for your own production costs. H&r block 2012 taxes 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. H&r block 2012 taxes Additional information. H&r block 2012 taxes   The procedures for applying the uniform capitalization rules are beyond the scope of this publication. H&r block 2012 taxes For more information, see sections 1. H&r block 2012 taxes 263A-8 through 1. H&r block 2012 taxes 263A-15 of the regulations and Notice 88-99. H&r block 2012 taxes Notice 88-99 is in Cumulative Bulletin 1988-2. H&r block 2012 taxes When To Deduct Interest If the uniform capitalization rules, discussed under Capitalization of Interest, earlier, do not apply to you, deduct interest as follows. H&r block 2012 taxes Cash method. H&r block 2012 taxes   Under the cash method, you can generally deduct only the interest you actually paid during the tax year. H&r block 2012 taxes You cannot deduct a promissory note you gave as payment because it is a promise to pay and not an actual payment. H&r block 2012 taxes Prepaid interest. H&r block 2012 taxes   You generally cannot deduct any interest paid before the year it is due. H&r block 2012 taxes Interest paid in advance can be deducted only in the tax year in which it is due. H&r block 2012 taxes Discounted loan. H&r block 2012 taxes   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. H&r block 2012 taxes For more information, see Original issue discount (OID) under Interest You Can Deduct, earlier. H&r block 2012 taxes Refunds of interest. H&r block 2012 taxes   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. H&r block 2012 taxes 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. H&r block 2012 taxes Accrual method. H&r block 2012 taxes   Under an accrual method, you can deduct only interest that has accrued during the tax year. H&r block 2012 taxes Prepaid interest. H&r block 2012 taxes   See Prepaid interest, earlier. H&r block 2012 taxes Discounted loan. H&r block 2012 taxes   See Discounted loan, earlier. H&r block 2012 taxes Tax deficiency. H&r block 2012 taxes   If you contest a federal income tax deficiency, interest does not accrue until the tax year the final determination of liability is made. H&r block 2012 taxes If you do not contest the deficiency, then the interest accrues in the year the tax was asserted and agreed to by you. H&r block 2012 taxes   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. H&r block 2012 taxes Related person. H&r block 2012 taxes   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. H&r block 2012 taxes The relationship is determined as of the end of the tax year for which the interest would otherwise be deductible. H&r block 2012 taxes See section 267 of the Internal Revenue Code for more information. H&r block 2012 taxes 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. H&r block 2012 taxes See Treatment of gift and demand loans, later, in this discussion. H&r block 2012 taxes 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. H&r block 2012 taxes 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. H&r block 2012 taxes A loan in exchange for a note that requires the payment of interest at the applicable federal rate. H&r block 2012 taxes An additional payment in an amount equal to the forgone interest. H&r block 2012 taxes 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. H&r block 2012 taxes Forgone interest. H&r block 2012 taxes   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. H&r block 2012 taxes Applicable federal rates are published by the IRS each month in the Internal Revenue Bulletin. H&r block 2012 taxes Internal Revenue Bulletins are available on the IRS web site at www. H&r block 2012 taxes irs. H&r block 2012 taxes gov/irb. H&r block 2012 taxes You can also contact an IRS office to get these rates. H&r block 2012 taxes Loans subject to the rules. H&r block 2012 taxes   The rules for below-market loans apply to the following. H&r block 2012 taxes Gift loans (below-market loans where the forgone interest is in the nature of a gift). H&r block 2012 taxes 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). H&r block 2012 taxes Corporation-shareholder loans. H&r block 2012 taxes Tax avoidance loans (below-market loans where the avoidance of federal tax is one of the main purposes of the interest arrangement). H&r block 2012 taxes Loans to qualified continuing care facilities under a continuing care contract (made after October 11, 1985). H&r block 2012 taxes   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. H&r block 2012 taxes Treatment of gift and demand loans. H&r block 2012 taxes   If you receive a below-market gift loan or demand loan, you are treated as receiving an additional payment (as a gift, dividend, etc. H&r block 2012 taxes ) equal to the forgone interest on the loan. H&r block 2012 taxes You are then treated as transferring this amount back to the lender as interest. H&r block 2012 taxes These transfers are considered to occur annually, generally on December 31. H&r block 2012 taxes If you use the loan proceeds in your trade or business, you can deduct the forgone interest each year as a business interest expense. H&r block 2012 taxes The lender must report it as interest income. H&r block 2012 taxes Limit on forgone interest for gift loans of $100,000 or less. H&r block 2012 taxes   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. H&r block 2012 taxes This limit applies if the outstanding loans between the lender and borrower total $100,000 or less. H&r block 2012 taxes If the borrower's net investment income is $1,000 or less, it is treated as zero. H&r block 2012 taxes 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. H&r block 2012 taxes Treatment of term loans. H&r block 2012 taxes   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. H&r block 2012 taxes ) on the date the loan is made. H&r block 2012 taxes This payment is equal to the loan amount minus the present value, at the applicable federal rate, of all payments due under the loan. H&r block 2012 taxes The same amount is treated as original issue discount on the loan. H&r block 2012 taxes See Original issue discount (OID) under Interest You Can Deduct, earlier. H&r block 2012 taxes Exceptions for loans of $10,000 or less. H&r block 2012 taxes   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. H&r block 2012 taxes This exception applies only to the following. H&r block 2012 taxes Gift loans between individuals if the loan is not directly used to buy or carry income-producing assets. H&r block 2012 taxes Compensation-related loans or corporation-shareholder loans if the avoidance of any federal tax is not a principal purpose of the interest arrangement. H&r block 2012 taxes This exception does not apply to a term loan described in (2) above that was previously subject to the below-market loan rules. H&r block 2012 taxes Those rules will continue to apply even if the outstanding balance is reduced to $10,000 or less. H&r block 2012 taxes Exceptions for loans without significant tax effect. H&r block 2012 taxes   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. H&r block 2012 taxes 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. H&r block 2012 taxes Loans subsidized by a federal, state, or municipal government that are made available under a program of general application to the public. H&r block 2012 taxes Certain employee-relocation loans. H&r block 2012 taxes Certain loans to or from a foreign person, unless the interest income would be effectively connected with the conduct of a U. H&r block 2012 taxes S. H&r block 2012 taxes trade or business and not exempt from U. H&r block 2012 taxes S. H&r block 2012 taxes tax under an income tax treaty. H&r block 2012 taxes 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. H&r block 2012 taxes 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. H&r block 2012 taxes Consider all the following factors. H&r block 2012 taxes Whether items of income and deduction generated by the loan offset each other. H&r block 2012 taxes The amount of the items. H&r block 2012 taxes The cost of complying with the below-market loan provisions if they were to apply. H&r block 2012 taxes Any reasons, other than taxes, for structuring the transaction as a below-market loan. H&r block 2012 taxes Exception for loans to qualified continuing care facilities. H&r block 2012 taxes   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. H&r block 2012 taxes A qualified continuing care facility is one or more facilities (excluding nursing homes) meeting the requirements listed below. H&r block 2012 taxes Designed to provide services under continuing care contracts (defined below). H&r block 2012 taxes Includes an independent living unit, and either an assisted living or nursing facility, or both. H&r block 2012 taxes Substantially all of the independent living unit residents are covered by continuing care contracts. H&r block 2012 taxes A continuing care contract is a written contract between an individual and a qualified continuing care facility that includes all of the following conditions. H&r block 2012 taxes The individual or individual's spouse must be entitled to use the facility for the rest of their life or lives. H&r block 2012 taxes 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. H&r block 2012 taxes 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. H&r block 2012 taxes For more information, see section 7872(h) of the Internal Revenue Code. H&r block 2012 taxes Sale or exchange of property. H&r block 2012 taxes   Different rules generally apply to a loan connected with the sale or exchange of property. H&r block 2012 taxes If the loan does not provide adequate stated interest, part of the principal payment may be considered interest. H&r block 2012 taxes However, there are exceptions that may require you to apply the below-market interest rate rules to these loans. H&r block 2012 taxes See Unstated Interest and Original Issue Discount (OID) in Publication 537. H&r block 2012 taxes More information. H&r block 2012 taxes   For more information on below-market loans, see section 7872 of the Internal Revenue Code and section 1. H&r block 2012 taxes 7872-5 of the regulations. H&r block 2012 taxes Prev  Up  Next   Home   More Online Publications