Can I finance an LLC loss?

[cmg1]

I understand a loss is when I have more bills than income and have to pay those bills from my own pocket.  I have a rental property owned by myself via an LLC. In 2019 I had a loss that I took on schedule E, lowering my taxes. Since I didn't have enough of my personal money to cover the cash (not depreciation) part of the loss, I borrowed the loss amount at the end of 2019. Can I now also expense on schedule E the 2020 interest on the money I borrowed to pay the bills causing the loss? Since income is still limited I am also borrowing the money to pay the interest (compounding, if you will). Can I also expense that on schedule E.

[ColeenD3]

No, personal loan interest is not deductible even if it is for a rental. The loan must be secured by real property.

A secured debt is one in which you sign an instrument (such as a mortgage, deed of trust, or land contract) that:

• Makes your ownership in a qualified property security for payment of the debt,

• Provides, in case of default, that your qualified property could satisfy the debt, and

• Is recorded or is otherwise perfected under any state or local law that applies.

In other words, your mortgage is a secured debt if you put your qualified property up as collateral to protect the interests of the lender. If you cannot pay the debt, your qualified property can then serve as payment to the lender to satisfy (pay) the debt

[cmg1]

To further muddy the waters.... I have a mortgage on my personal home, that I refinanced years ago for more than the original loan amount. I read that "Interest Tracing Rules" say interest can allocated between the home (personal) and investments, which is what I have done for the purchase of the rental and then the losses. and placed that amount on schedule E.  I realize I could take it all on schedule A, but the new standard deduction eliminates that possibility, that is why sched E. 

[Carl]

Residential Rental Real Estate reported on SCH E will almost always operate at a loss every single year, *on paper* at tax filing time. Especially if you have a mortgage on it. When you add up the deductible expenses of mortgage interest, property taxes, property insurance and add that to the depreciation you are required to take on rental property every year, those four expenses alone are usually enough to exceed the total rental income received in the tax year. Add to that the other allowed rental expenses (repairs, maintenance, etc) and you're practically guaranteed to show a loss *ON PAPER* at tax filing time. So it's just not all that common for residential rental property to actually produce a taxable income. In fact, it's more common for rental property of this type to operate at a loss every year.

Once you're rental expenses get your taxable rental income to zero, that's it. Any excess losses are just carried forward to the next year. (See exception below). So your losses will just continue to grow with each passing year you rent the property out. You can't realize those losses until the tax year you sell the property. In the tax year you sell, all of your carry over losses are used first to offset the taxable gain on the sale of the property, and then to offset the tax on "other" ordinary income.

Exception: If you are "actively involved" in the management of the rental property, then you are allowed to deduct up to $25K of excess losses on rental property against other ordinary income, provided you have that "other" ordinary income that would otherwise be taxable, to deduct it from. The TTX program takes care of this "for you" automatically in the background without bothering you with the details.

[Rick19744]

To address your initial question, if you borrowed $$ that were used directly for your rental property, then you will be able to deduct that interest expense under the tracing rules.

A key here is that you are able to show that your rental and your personal accounts (records) are separate.  If not, that will muddy the waters if you win the audit lottery.

In general, interest expense on a debt is allocated in the same manner as the debt to which such interest expense relates is allocated. Debt is allocated by tracing disbursements of the debt proceeds to specific expenditures. This section prescribes rules for tracing debt proceeds to specific expenditures. (Reg Section 1.163-8T(a)(3))­.

Your second question is too involved of an issue to be able to address that in a forum such as this.  Too many additional facts and information needed to respond accurately.

[Mike9241]

but, the taxpayer is saying that the interest is not being paid. it's being borrowed and added to the balance due. if the taxpayer is cash basis, and generally they are for rental activities, the interest is not deductible because it has not been paid. 

[Rick19744 · Accepted solution]

My reading of this is as follows:

• The OP indicated they borrowed $$ to cover expenses
• The OP then asked if they can deduct the interest on the borrowed $$ - answer is "yes"
• The OP further stated that they continue to borrow $$ to pay the interest.
• So essentially the interest is being paid, it's just that it's being paid by borrowed $$ again.
• I just don't read this as indicating that the interest is just accruing and not being paid.  If my interpretation of the facts is incorrect, and the interest is not getting paid, then I agree no interest expense deduction until actually paid.
• Borrowing $$ to pay interest is no different than borrowing $$ to purchase supplies, etc.  Both are a deductible expense using the borrowed $$.