Investment Interest or to be capitalized

[Gretel]

I just confused myself.

Client starts a huge apartment complex with construction loan and a couple of loans to cover his equity. Is the interest for these equity loans considered to be part of the project and hence need to be capitalized (this is what I believe), or is this investment interest?

After the building is completed it probably will be investment interest if still outstanding, but I am unsure about the building period.

[Gretel]

Just trying to get an opinion.

[Gretel]

I know my chances are slim at this point in time. I don't want to have this lost.

[ddoshan]

Wiser folks may pipe in but .... It would seem that the interest would be capitalized initially. I would think that once the complex is complete and units are rented out that the interest would be a normal expense against income.

[JG EA]

Although not wise, I agree - interest should be capitalized.

[Gretel]

Thanks, now lets move on to step two (this is not a trap I didn't think about this when I posted but I will come up soon).

How does a partnership deal with this? Equity for partner 1 comes from his own equity, equity from partner 2 comes from a loan. It would not be fair to add these interest expenses to the construction project.

Maybe in this case it is considered a contribution to his partnership interest and that makes it investment interest? Wouldn't be fair either.

[JG EA]

Thanks, now lets move on to step two (this is not a trap I didn't think about this when I posted but I will come up soon).

How does a partnership deal with this? Equity for partner 1 comes from his own equity, equity from partner 2 comes from a loan. It would not be fair to add these interest expenses to the construction project.

Maybe in this case it is considered a contribution to his partnership interest and that makes it investment interest? Wouldn't be fair either.

Does the partnership pay the loan? Or does just one partner pay the loan? Why is it not fair if the partnership pays the interest? I'm not getting the picture sorry, But what I can do is give it a bump for you.

[Gretel]

Does the partnership pay the loan? Or does just one partner pay the loan? Why is it not fair if the partnership pays the interest? I'm not getting the picture sorry, But what I can do is give it a bump for you.

No, partner #1 (who has enough funds on hand to come up with his full equity in project) has nothing to do with partner #2 loan, hence no partnership expense. Why would he want to pay 50% of that interest?

Thanks for the bump.

[JG EA]

So, if one partner borrowed money just to buy into the partnership and the partnership builds the building, then I take it back that the interest is capitalized. If the loan is not connected to the building then it is just his personal loan to buy into the partnership.

[Gretel]

So, if one partner borrowed money just to buy into the partnership and the partnership builds the building, then I take it back that the interest is capitalized. If the loan is not connected to the building then it is just his personal loan to buy into the partnership.

That exactly is the question. The partnership started with some equal contribution from both partners. Then they get this construction loan, but each of them has to come up with equity for this project. This personal loan is connected to the project since it is for the equity part of the project. How then would the interest be capitalized if the other partner has nothing to do with this loan. But if this equity is considered a contribution to the partnership, then it is investment interest.

See my dilemma. I can't even start to think how the capitalization would work.

On the other hand (my client, the one with the loans also does these projects as single-member LLC) if the interest on these personal loans for equity need to capitalized, then I see no reason why it would change being in a partnership.

This is very complex (at least for me). Maybe I need to post to NAEA.

Thanks JG, trying to help me to figure this one out and sorry, for any confusing description of my dilemma.
My client, one partner (the one with the loan), does both, some are in a partnership, some are as single-member LLC. Now, the interest on the equity required (always covered by other loans) needs to be capitalized

[JG EA]

I am so sorry I am the only one answering since this is not a sure thing with me. But you are talking about equity in the building. But is it not just money from each to get the partnership going??? So, the loan the one partner took out for that isn't secured by the building is it? Then it is just a personal loan. He can trace the money going to an investment and count it as investment interest - I think so anyway.

[Gretel]

I am so sorry I am the only one answering since this is not a sure thing with me. But you are talking about equity in the building. But is it not just money from each to get the partnership going??? So, the loan the one partner took out for that isn't secured by the building is it? Then it is just a personal loan. He can trace the money going to an investment and count it as investment interest - I think so anyway.

I know, me too. But this is what I meant in an earlier post in this thread that this is not fair if the same things happens for a Schedule C filer and he has to capitalize. Maybe a reward for a business structure/biz return?

I will do more digging after tax season and will post again. Thanks JG for hanging in there with me.