Accounting question

[OldJack]

So, would you say that this is true if the T/P actually made payments (which are usually interest only) on the construction loan and received a 1098 for interest paid? Or, is it just when the interest is added back into the loan and no payments have been made?

Construction interest expense is different on a personal residence verses rental property. We have been discussing rental property here. Construction period interest expense on business rental property must be capitalized as part of the cost of the property. TTB 8-15

Construction interest expense on a personal residence may be deducted if the construction is within 2 years (24 months), but any construction interest prior is capitalized. TTB 4-13

The fact that there is a 1098 does not mean the interest is always deductible, it only means the loan company has classified it as mortgage interest.

[peggysioux]

Old Jack,

You stated:

"Construction interest expense is different on a personal residence verses rental property. We have been discussing rental property here. Construction period interest expense on business rental property must be capitalized as part of the cost of the property. TTB 8-15

Construction interest expense on a personal residence may be deducted if the construction is within 2 years (24 months), but any construction interest prior is capitalized. TTB 4-13

The fact that there is a 1098 does not mean the interest is always deductible, it only means the loan company has classified it as mortgage interest."


I just wanted to confirm that if construction was for personal residence, the interest WOULD be deductible from a 1098 even if taxpayer paid nothing on loan in 2006 (first year of construction loan - will be completed within 24 months) and interest will be rolled into refi in 2007. Sorry to be so thick headed and keep coming back to this. As always, thanks for your help!!!!

[OldJack]

I just wanted to confirm that if construction was for personal residence, the interest WOULD be deductible from a 1098 even if taxpayer paid nothing on loan in 2006 (first year of construction loan - will be completed within 24 months) and interest will be rolled into refi in 2007. Sorry to be so thick headed and keep coming back to this. As always, thanks for your help!!!!

TTB 4-13 says that interest from the date constructions starts would be deductible for the first 24 months. In your case as it is a personal residence and this is the first year of construction it would be deductible if there was no interest portion prior to the day construction began. Prior portion would not be deductible.

[Bees Knees]

Accrued interest of a cash basis taxpayer is not deductible until actually paid.

Just because the bank reports accrued interest as income does not mean the taxpayer that is liable for the interest gets a deduction for interest paid. The income and expense reporting for the same interest does not have to coincide with each other.

The instructions for Form 1098 tell the bank to ONLY include interest actually received from the borrower. Nothing about including interest billed to the borrower. Even though the bank may be counting the accrued interest in its income, it does not add that interest to the 1098. Thus, the 1098 will only reflect interest actually paid by the borrower.

The accounting method for accrued business interest is no different. Cash basis taxpayers deduct interest actually paid. Accrual basis taxpayers deduct interest incurred. It is irrelevant when the bank records the interest in its books as income.

[Zee]

Just because the bank reports accrued interest as income does not mean the taxpayer that is liable for the interest gets a deduction for interest paid. The income and expense reporting for the same interest does not have to coincide with each other.

The instructions for Form 1098 tell the bank to ONLY include interest actually received from the borrower. Nothing about including interest billed to the borrower. Even though the bank may be counting the accrued interest in its income, it does not add that interest to the 1098. Thus, the 1098 will only reflect interest actually paid by the borrower.

The accounting method for accrued business interest is no different. Cash basis taxpayers deduct interest actually paid. Accrual basis taxpayers deduct interest incurred. It is irrelevant when the bank records the interest in its books as income.

I would agree. I also read the SEC and other banking regulatory groups are looking closely at the practice of the banks recording of negative interest as revenues each year. This is a very "risky" and "misleading" reporting practice in a RE downturn like we're experiencing currently. Of course, this has nothing to do with the question. Just interesting discussion.

[OldJack]

I will repeat my original comment:

>>Contrary to some people's thinking cash basis does not just mean a disbursement from a checking account!! This interest has been paid by way of loan proceeds, much the same as if the loan had been paid to the taxpayer and the taxpayer then wrote a check from the checking account paying the interest. The loan company is not going to charge the same interest on the same balance again so any deferral is in the mind of the debtor.

I would also point out that proof of payment is covered by Rev Proc 92-71 where it says that a statement can be used as proof of payment.<<

The loan proceed payments are not accruals for this taxpayer, rather they are in fact actual payments credited to his account.

[Zee]

I will repeat my original comment:

>>Contrary to some people's thinking cash basis does not just mean a disbursement from a checking account!! This interest has been paid by way of loan proceeds, much the same as if the loan had been paid to the taxpayer and the taxpayer then wrote a check from the checking account paying the interest. The loan company is not going to charge the same interest on the same balance again so any deferral is in the mind of the debtor.

I would also point out that proof of payment is covered by Rev Proc 92-71 where it says that a statement can be used as proof of payment.<<

The loan proceed payments are not accruals for this taxpayer, rather they are in fact actual payments credited to his account.

Old Jack-

I greatly respect your opinion and helpful posts. However, I don't think the deductibility of negative interest by the borrower is unquestionably a black & white issues. I will certainly agree that if negative interest is reported on the 1098, it will be very difficult to convince a tax client it shouldn't be deducted. And, maybe not worth the effort. From a practical standpoint, we're not IRS auditors. I'm not sure it's a due diligence responsibility to determine how 1098 mortgage interest reported on the 1098 was calculated by the bank (unless it's known to be in error). Of course, my opinion might be subject to much disagreement on this BBS.

It seems more of a gray area to me. If the "interest has been paid by way of the loan proceeds, why would the bank continue to show an Account Receivable" for the interest component. In my opinion, It hasn't been "paid". It's simply been recorded by the bank as Revenue with an Account Receivable from the customer. I believe in most cases, negative interest isn't payable until the loan maturity or balloon date.

We're all well aware that a cash-basis taxpayer can deduct credit card purchases as being paid at the time of the charge, but this situation isn't quite the same.

[OldJack]

Zee,

My last comment on this post is that the original post said "Client has rental house in a partnership LLC ". This is a business entity loan and the loan companies usually don't issue 1098's on a business loan.

It is common in cash basis accounting that a business loan is shown as a liability since it is involved in a proceeds deposit or property acquired transaction. It would be incorrect in either cash basis or accrual basis to not adjust the loan account to the same amount as reported by the loan company as the financial statement would be incorrect when presented to 3rd parties, including the loan company.

I expect the loan company entries would be something like this:
1.Normal entry charging of interest:
Debit - Interest receivable Due from Customer (A/Rec)
Credit - Interest Income for loan company

2.Normal entry for additional Loan:
Debit - Loan Principal due from Customer
Credit - Interest receivable Due from Customer (zero's A/Rec interest due)

The only question is does the payment get debited to interest expense or the other asset account deferred interest. Holding such interest in the deferred account will likely lump the deduction into one year, distorting income, if the loan is paid-off early which is probable as the taxpayers need to get out of this loan as soon as they can.

I don't believe the original post indicated that the loan company continued to show an "accounts receivable for the interest" (rather additional principal) as in this case there were new loans to cover the interest payments. The loan company can't call the debt principal due and interest due for the same amount. Additional loans would have to be principal or they could not collect interest on them.

[Zee]

Old Jack- Thanks again for your input.

I'm not sure how to respond. Of course, the interest would be recorded as an Accounts Receivable on the banks records if they're recording revenue. The point is an Accounts Receivable indicates the interest has not been paid whether or not it's recorded as a deferred receivable or current receivable. In my opinion, interest is deducted when paid for a cash-basis taxpayer. It hasn't been "paid", I don't think it's deductible. We both just seem to be repeating our arguments. I guess we'll just have to "agree to disagree" on this one unless I'm presented a more convincing argument. I sure would like to hear from our Tax Book authors. How do we get their input? Trust me, if deducting the interest appears a good choice and will benefit the client that's what I'd recommend(or, give the clients a choice if a not too gray area). I'm just not as convinced as you seem to be.