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.
*A reminder that posts in a forum such as this do not constitute tax advice.
Also keep in mind the date of replies, as tax law changes.
