Interest tracing

[KWF]

A taxpayer conducts a business as a single shareholder S corp. He also personally rents (Sch E) a building to the S corp to carry on its business.

When the building had a $70,000 existing mortgage balance, t/p refinances building mortgage with a new $100,000 mortgage. He takes the $30,000 cash he received in the refinancing, and contributes it the S corp as additional paid in capital.

Question: how & where is the building mortgage interest deducted?

I assume 70% of the interest is deducted on Sch E, but how is the remaining 30% of interest treated? Is it deducted as business interest on S corp 1120S, or as investment interest on 4952, or is it deductible at all?

[Snaggletooth]

Deductible on 4952

I'm going out on a limb and try to address this.

The usage of the additional $30,000 determines where the interest is "traced". Since all of the proceeds were deposited into the S corp and he recorded this as paid-in-capital, there is no "loan" on the books of the S Corp to support interest expense.

Used as paid-in-capital, this becomes "investment" rather than a loan to the corporation. 4952 appears to me the only option.

If he had "loaned" the $30,000 to the corporation, and they paid a portion (like 30%) of the debt service, I believe the corporation would be entitled to the deduction for their portion of the interest. This would have been a much stronger deduction for the taxpayer than deducting on Form 4952. And the loan on the balance sheet would be reduced concurrent with its portion of the loan principle.

[BHoffman]

I will join Snags on the limb. See the link below, page 12, “How to report”, see if the 1st sentence fits your scenario.

https://www.irs.gov/pub/irs-pdf/p535.pdf#page11

HTH and good luck.