HELOC proceeds used for business purposes

[mhcpa1964]

Hello all,

Client bought property A in their personal name. Acquisition proceeds for property A are from a HELOC in their personal name. The HELOC is collateralized by their primary residence (which is a different property). Property A is used as storage for their business equipment. That business is a S corp.

Can the S corp pay the HELOC so their S corp can claim business interest expense? The shareholders ratified a corporate resolution for the S corp to pay the operating expenses on this property.

The S corp is NOT paying rent on property A. It seems to me that since there is no rental income then there is no business interest expense.

Thanks in advance to anyone who chimes in.

[Uncle Sam]

The S Corp can only pay and deduct expenses for property IT OWNS in its own name.
In whose name is the insurance policy under - the S corp's or the shareholders?

[mhcpa1964]

Thanks Sam. I'll ask the client how the insurance policy is named.

[Uncle Sam]

In thinking about this - do the shareholders have the legal authority under the zoning ordinances to actually use the property for business purposes? So you have other issues to consider besides only the income tax considerations?

[Maribeth]

Yes, the S corp can pay the monthly payments on the HELOC. On the corporate books, that payment would be recorded as rent expense and deducted as same on the corporate tax return. On the shareholder's return, they will have rental income for the amounts paid by the corporation. And if they use the tracing rules, they probably have an interest expense deduction on their Schedule E. But check this, I think we can still use tracing rules on a HELOC since TCJA.

And, of course, this property must be a separate property, not part of their personal residence.

[mhcpa1964]

Sam, yes they do. The property is zoned commercial. It's an abandoned drive through beverage store that the client uses to store their business' equipment.

There is no rent payment between the business and themselves.

I was hoping an accountable plan would be the solution.

[mhcpa1964]

Except for the fact the title is in their personal name, the property is business use.

[Rapid Robert]

"The shareholders ratified a corporate resolution for the S corp to pay the operating expenses on this property."

Interest is not an operating expense unless you are a bank or other type of lender.

"The S corp is NOT paying rent on property A. It seems to me that since there is no rental income then there is no business interest expense. [...] There is no rent payment between the business and themselves. "

Yes it is paying rent. See post number 5 by Maribeth, that seems to me to be an accurate take on the tax treatment of this arrangement. You have been coy about stating whether or not the client is an officer/shareholder of the S-corp, but it sounds like a self-rental situation, which has certain restrictions.

"I was hoping an accountable plan would be the solution."

No. Accountable plans pertain to reimbursing employee business expenses. "Your expenses must have a business connection—that is, you must have paid or incurred deductible expenses while performing services as an employee of your employer." (Pub 463). Paying loan interest on a storage building is not related to performing services as an employee.

[Uncle Sam]

I still fail to see where a personal debt of the shareholder(s) for the use of the business where the asset involved is owned personally provides a legitimate business expense for the corporation?
The S corp can physically write a check to pay the debt off, but no part of the payment, the way I see it, constitutes a legitimate business expense.

[mhcpa1964]

Thank you all for the feedback.

The S corp is owned by a husband and wife who are officers and employees. They bought the property in their personal names for reasons I'm still not clear on, so I'll have to get a better understanding of why. It's possible they couldn't get a business loan for the deal. Or that the costs of a commercial loan were too expensive.

We're in Florida, and rent income is subject to sales tax, so they wanted to avoid that hurdle.

Maribeth's suggestions sound reasonable, but I'll talk with clients more to confirm if there's any personal use of this property.