Debt Financed Acquisition interest on LLC / Partnership

[Bjorn]

Most software will lower the 1040 federal income on the back of Schedule E by the debt-financed acquisition interest. I have also claimed a reduction in Self Employment income. In my system, it was a non-farm negative SE adjustment. I'm looking for clarity if this is a valid deduction. The client has a 400,000 loan and a large income so the savings in Medicare Tax will be substantial.

Thank you in advance for the feedback.

Aloha,
Bjorn

[ATSMAN]

From CPA Journal:



Reporting Interest Expense

Individuals report deductible interest expense incurred in connection with debt-financed acquisitions of pass-through entities on either Schedule A or Schedule E, depending on how the interest expense is classified.

Investment interest expense is first reported on Form 4952, Investment Interest Expense. To the extent that investment interest expense is deductible, it is reported on Schedule A as an itemized deduction not subject to the overall limitation on itemized deductions that affects taxpayers with adjusted gross incomes above a specified threshold. Any investment interest expense disallowed on Form 4952 is carried forward to subsequent years. The election to include all or part of net long-term capital gains in investment income is made by including the amount on the applicable line on Form 4952. The amount of net long-term capital gain included in investment income must be deducted from the total net long-term capital gain eligible for the more favorable capital gain tax rate on Schedule D. Once the election is made for a particular year it may not be revoked without IRS consent.

Treasury Regulations section 1.469-1T(e)(6) states that taxpayers in partnerships whose activity consists of trading personal property, such as stocks, bonds, and other securities, are not involved in a passive activity.

The K-1s from these trading partnerships generally state that the activity is neither passive nor portfolio. If the partner does not materially participate in such a partnership's activity, the individual is advised that interest expense passed through is subject to the investment interest expense limitations on Form 4952 but is then deductible on Schedule E rather than Schedule A.

Passive interest expense is deductible on Schedule E after applying the passive loss limitation rules of IRC section 469. Form 8582, Passive Activity Loss Limitations, and its supporting worksheets are generally used to determine the deductibility of passive activity losses.

Active interest expense is deductible on Schedule E, along with losses from pass-through entities of trades or businesses in which the taxpayer materially participates. *

[JON]

Does that sound right? I used to think S Corp stock was the only acquisition interest expense that was on Schedule E, and all the rest was Investment Interest??

[Bjorn]

NATP research stated that the interest "presumably" would lower SE income. If memory serves Baker Tilly did lower SE income but Grant Thornton did not.