Deduct Interest Paid on the Purchase of an LLC

[taylorasteele]

I purchased an additional 10% of our LLC (taxed as Partnership) from a partner as of 1/1/15. She and I signed a note payable and I have been making payments which included Interest. What I can’t find good information on is if I can deduct the interest against my LLC income on Schedule E Part II or if it has to go to schedule A.

Of the purchase 98% has been allocated to Goodwill and is being amortized as a 754 election and the other piece was a capital purchase of essentially the cash and office furniture.

All income from the LLC is self-employment income so there is no investment income to offset on schedule A which makes that deduction meaningless. There is a much greater benefit to it being on Schedule E, but I don’t want to do anything incorrectly. Do you know what the regulations are about this?

[Rick19744 · Accepted solution]

You can deduct this as a separately stated line item on your Sch E.  See below:

Based on the discussion in IRS notice 89-35 (also see letter ruling 9037027), interest expense on indebtedness used to purchase stock in an S corporation or a partnership interest, or to make a contribution to such entities, can be treated as fully deductible business  interest expense  if all of the following conditions are met:

1. The taxpayer materially participates in the partnership's or S corporation's business  operations.
2. The partnership's or S corporation's assets are used solely in conducting an active trade or business and not for passive or portfolio activities.
3. No debt-financed distributions to partners or shareholders have been made. (However, interest from debt used to make distributions may be fully deductible as business  interest. (I doubt this applies to your situation).

Trade or business  interest  expense  incurred in connection with interests in partnerships or S corporations should be reported on Part II of Schedule E. Per IRS Notice 88-37, the interest  expense  should be reported on a separate line and identified as “business  interest” with the name of the pass-through entity indicated. For partnerships, this interest would presumably also reduce self-employment (SE) income and therefore reduce SE tax. 

[taylorasteele]

Thank you Rick. Most helpful. A quick note - Your links to the IRS Notices and PLR go to a site  (Checkpoint) that you have to have a login. I was able to web search and find each to read, but wanted to make you aware for future answers that you try to link items for people.

[Rick19744]

Noted and I changed it so there would be no link.  Thanks.