Private loan interest deduction

[robpow05]

Hello,

I have a very specific and semi unusual question.

I am buying a commercial rental house from the two relatives. They each will be providing me a private loan to finance my buying of the house in the amount of their respective share of the house. I will be buying the property through a recently established LLC.

The questions are:

I believe I can deduct the loan interest off of my operating expenses? Is this correct? Is there anything special that I need to setup in the contracts?

On the flip side, I believe the sellers will need to claim the interest paid to them through the loan as income?

Will we need to setup 1099s for this interest income, or is it sufficient to just report the amounts on our taxes with no official form, just our personal leger that we used to track the principle and interest paid through the year?

Thanks,

POW

[mellish7777]

They have to report the interest as income and you can deduct the interest you paid them and keep in mind that the interest has to be at the market rate. A 1099INT is only issued when payments are made in the course of a trade or business and that's not happening here.

[Anonymous]

the loans should be supported by written documentation.  Things happen and then you could end up in court. it then becomes a case of you say relative says and the judge is the one who flips the coin.  Free documents are available on the web. 

[Opus 17]

You can deduct the interest on any loan that is used for business as a business expense, whether from a private lender or a bank.  The most important part is to keep your documentation that shows you can trace the interest payment back to the specific business purpose, and don't mix loans.  

(For example, you can even deduct credit card interest if you use the credit card for business purposes, but as soon as you put personal expenses on the same card, the interest becomes mixed up and the IRS would not look favorably on continuing to deduct the interest as a business expense.) 

[timothyyoungs]

I'm in a similar boat. I borrowed from a family member to purchase an investment property. The private loan is at the current market rate for interest, and we have a signed agreement.

I would like to enter the interest that I am paying, but I don't know how. TurboTax has two fields for Lender and amount of interest paid. Do I just enter the individuals name? Or should I record it somewhere else?

Thanks!

[DaveF1006]

Yes but you would not report this as mortgage interest.  Instead it is reported as an investment interest expense.

1. Go to federal>deductions and credits>Retirement and Investments>show more
2. Investment Interest Expenses>start

[timothyyoungs]

Thanks for responding!

The thing is that I want to add it to my schedule E. With the interest recorded against my rental income, I would be eligible for the EITC (I believe the max I can earn on a rental is $3,600 to claim the EITC — right now I'm over that amount).

Can I add it under "Other Interest" on the Schedule E?

[robpow05]

Fun one yes. The good news is I believe the interest can be deducted as an annual expense that can offset your rental revenue. The part that gets tricky is that I believe that rental revenue and expenses need to be detail on I believe form E.  I am putting my rental in an LLC, which I believe will go through the same form. With that said, I did some digging and because this is a small business, I will need to download and use the Turbo tax home and business to run the business portion of my taxes.  I don't know your situation, but that might be why you are not seeing what you are looking for. Full disclosure, I have not yet gone through a tax season with the LLC in play with a business going through it, so this information is based on my googling.

[DaveF1006]

After reading these regulations a little more thoroughly and conferring with Opus 17, I agree with your assessment.  After reading and taking this into account, I advise to go ahead and list your relative's name and the amount of mortgage expense paid as a rental expense. 

My only reservation about claiming this is that without a 1098, this could trigger an audit and i didn't wish for you to risk this.  However, while the lack of a 1098 may trigger an audit, as long as you you have loan documents and proof of payments, you should be able to claim this interest. if there is an audit, be sure to have the loan documents and proof of payments as proof. Also be sure to be able to cite those instructions that you listed above.

[Edited 02-17-2021|03:48 PM PST]

[Opus 17]

@DaveF1006 That is not quite correct, read the instructions. It depends on whether the relative made the loan in the course of the relative’s business, even if he is not a lender, or if the relative made the loan in a personal capacity.

Not in the lending business.

If you receive mortgage interest of $600 or more in the course of your trade or business, you are subject to the requirement to file Form 1098, even if you are not in the business of lending money. For example, if you are a real estate developer and you provide financing to an individual to buy a home in your subdivision, and that home is security for the financing, you are subject to this reporting requirement. However, if you are a physician not engaged in any other business and you lend money to an individual to buy your home, you are not subject to this reporting requirement because you did not receive the interest in the course of your trade or business as a physician

[Opus 17]

@DaveF1006 I’m not clear that this is “investment interest.” It appears to be interest on a rental property.

Generally speaking, investment interest, such as money you borrowed to buy stocks, would be a miscellaneous itemized deduction subject to the 2% rule. That deduction was eliminated in 2018 for the federal tax return, although you can still list it in TurboTax because it may be deductible in your state.

However, interest incurred in borrowing money to purchase a rental property is probably deductible on schedule E, even if it is not a secured mortgage, as long as the tracing rules can be applied.  The borrower can certainly claim interest that the borrower paid even if the borrower does not receive a 1098 form. The lack of a 1098 may trigger an IRS letter, but if the borrower can prove the interest paid by showing loan documents, then the burden falls on the lender for not issuing the 1098.

[timothyyoungs]

It looks like that only applies if the loan was issued in the course of business. The person I borrowed from is not in a related business, nor are lender.

"Not in the lending business.

If you receive mortgage interest of $600 or more in the course of your trade or business, you are subject to the requirement to file Form 1098, even if you are not in the business of lending money. For example, if you are a real estate developer and you provide financing to an individual to buy a home in your subdivision, and that home is security for the financing, you are subject to this reporting requirement. However, if you are a physician not engaged in any other business and you lend money to an individual to buy your home, you are not subject to this reporting requirement because you did not receive the interest in the course of your trade or business as a physician."

[DaveF1006]

After reading these regulations a little more thoroughly and conferring with Opus 17, I agree with your assessment.  After reading and taking this into account, I advise to go ahead and list your relative's name and the amount of mortgage expense paid as a rental expense. 

My only reservation about claiming this is that without a 1098, this could trigger an audit and i didn't wish for you to risk this.  However, while the lack of a 1098 may trigger an audit, as long as you you have loan documents and proof of payments, you should be able to claim this interest. if there is an audit, be sure to have the loan documents and proof of payments as proof. Also be sure to be able to cite those instructions that you listed above.

[sfsnowboarder]

I thought that investment interest expenses is not subjected to the 2% rule.   Investment expense; however, is subjected to the 2% rule.