Interest expense - invest in LLC

[KJ Judd]

Does investing in a LLC affect where you deduct your interest on money your borrowed to invest? Interest expense to invest in a partnership or S corporation is deductible on pg 2 of Schedule E. Is this impacted by the "limited liability" part of an LLC? I had this down as Sch. E and now I'm doubting myself and thinking possibly Sch. A investment interest. Thanks for your help!

[OldJack]

It is investment interest expense limited to investment income. If the LLC reimburses you for the money as a loan you would have Investment income and less LLC taxable income.

[veritas]

Feel free to correct me

Oldjack and I know you like to. But where interest paid to aquire stock in an S Corp is deducted depends on the underlying assets. So if the assets consisted in say equities it would be deductible on Sch A as investment interest. If the assets consisted of equipment and inventory the interest would be deductible on page 2 of Sch E.

So since the IRS loves to point out to us every time it benefits them that S Corporations are predicated on partnerships why not use the same approach for money borrowed to purchase an LLC taxed as a partnership?

p.s. I like your quotes.

[OldJack]

But where interest paid to aquire stock in an S Corp is deducted depends on the underlying assets.

Well... that is the first that I have heard of that Veritas. You could be right, I really don't know. Despite the flow through "Separately Stated Items" concept, I don't believe there is any comparison between partnership tax and corporation tax. Corporate stock is corporate stock regardless if a C-corp or S-corp and I don't believe that underlying assets has anything to do with investment interest expense incurred by a taxpayer due to purchase of stock. Do you have a reference for me to read?

[veritas]

nope

It's just something rattling around in the back of my mind. I was hoping you had heard or read the same thing.

[DTS]

Two cents

I just had a situation this last week and I put the amount of the interest paid on his loan as "business loan interest" under this partner's unreimbursed expenses. I don't know if this was the right place or not, but that's what I thought.

Dennis

[veritas]

Found this from Audit Technique guide

Notice the exclamation point at the end of first sentence.


"Interest expense to buy rental real estate, an equipment leasing activity, or an investment in a partnership or S Corporation is not investment interest! If the borrowed funds were used to buy rental real estate or equipment leasing or a Form 1065/1120S in which the taxpayer does not materially participate, that interest expense is passive activity interest and belongs on Form 8582. In the absence of passive income, it is generally not deductible. Reg. § 1.469-2T(d)(3), § 1.163-8T(a)(4)(B) and Notice 89-35"

http://www.irs.gov/businesses/small/article/0,,id=146820,00.html

[DTS]

Follow-up question

This fellow is not involved in a passive activity, all material participation. Can I assume this does not apply?

Thanks,

Dennis

[veritas]

What I read in this is

interest paid to aquire a S Corp or a partnership is a business deduction and is taken currently unless passive activity rules come into play.

[DTS]

Yes...

that's how I read it, as well.

Thanks,

Dennis

[veritas]

This is interesting

Note that the IRS has ruled privately that investment interest on debt incurred to purchase C corporation stock can be recharacterized as trade or business interest when corporations convert from C status to S status. PLRs 9037027, 9040066.

[veritas]

An excerpt from PLR 9037027

This I believe relates to my statement about allocating interest to the undelying assets in the S Corporation.

The temporary regulations do not provide guidance relating to the
treatment of debt allocated to expenditures for interests in passthrough
entities such as S corporations. However, Notice 89-35, 1989-1 C.B. 675,
provides guidance on the allocation of interest expense in connection with
transactions involving passthrough entities. Under the notice, in the case
of debt proceeds allocated under section 1.163-8T of the temporary
regulations to the purchase of an interest in a passthrough entity, the
debt proceeds and the associated interest expense will be allocated among
all of the assets of the entity using any reasonable method. Reasonable
methods of allocation include a pro-rata allocation based on the
fair-market value, book value, or the adjusted basis of the assets,
reduced by any debt of the passthrough entity or the owner allocated to
the assets. Whether a particular method of allocating debt proceeds used
to purchase an interest in a passthrough entity is reasonable depends on
the facts and circumstances including, without limitation, whether the
taxpayer consistently applies the method from year to year. As a result,
under the notice, any debt and associated interest allocated to property
of a type that produces portfolio income would be considered allocated to
investment property and so would be treated as investment interest.
Furthermore, any debt and associated interest expense allocated to assets
used in a trade or business in which the taxpayer does not materially
participate would be treated as passive. However, debt and associated
interest allocated to assets used in a trade or business in which the
taxpayer materially participates would not be subject to the limitation of
section 163(d) of the Code. The rules of the notice are effective for
taxable years of owners of passthrough entities ending after December 31,
1987, and on or before the date that further guidance is published.

[OldJack]

>>..to purchase an interest in a passthrough entity.. <<

Stock is a capital asset defined in code §1221 by not being identified as an asset in a trade or business. I have never thought about it but I would expect the act of owning a capital asset would itself be considered passive. When you own stock all you can do with it is frame it to hang on the wall, file it in a file, and go vote at a meeting. That sounds like passive to me.

The term "purchase an interest" is commonly used with a partnership or LLC-1065 type entity. That kind of terminology is not usually used when describing the purchase of corporate stock. I am not convinced yet as I read the notice as not pertaining to corporate stock. I have deducted interest on Sch-E, page 2, but it was not for purchase of corporate stock, rather it was for loan debt which was a business interest debt.

I have not read your cite PLRs 9037027, 9040066. Its a little late tonight and quite busy tomorrow. How about a clip from there?

[Bill Tubbs]

excerpt from S-Corp

I was just working on an S Corp shareholder's return last night. In the packet they got from the S Corp, they say:

"Interest on funds you personally borrowed to acquire <company name> stock is not investment interest and is fully deductible. Enter the amount of your interest expense relating to <company name> stock on Schedule E, Page 2, Part II, line C, column (h)."

I would hope that the accountant that prepared this has some backing for it. In my reasearch last summer, I could not find anything that specifically said to report it as such. But I did find that said interest is not investment interest.

Bill

[KJ Judd]

I agree with Bill on reporting the interest on Schedule E pg 2 for an S corporation. I just wondered if being "limited liability" in the LLC affected the deduction.