Client mortgaged home to purchase business. Schedule C filer. There was a clear paper trail that funds from loan were used specifically to purchase the business. Mortgage interest has been taken on Sch. C as a business expense. Client sold business and did not pay down loan with sale proceeds. Business never generated an income and they said they needed the money to live on. Can the mortgage interest continue to be used as a Sch C expense after the sale or has it been converted to personal debt since proceeds of sale were not applied to it. I am thinking no more Sch C write off but thought I would check this out. Thank you.
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I've done it
Deborah, I've done it, but only after giving the situation the benefit of the doubt.
In my case, the proprietorship lost so much money that when they sold it, there were not enough proceeds to pay off the loan. I deducted $3700 as interest expense on Sch. C, with no other entries, and a $3700 loss.
Client got audited, and auditor proposed moving interest to Schedule A. I went to audit and explained that the loan was left over after business was sold. Auditor agreed it was a business deduction on Schedule C. Keep in mind, however, this was in the late '80s, the auditor was very complicitous, and there were not a lot of dollars at stake. -
TTB, page 4-11, talks about the election to treat mortgage interest as not secured by the primary residence so the taxpayer can deduct the interest for business, etc. "The election applies for the year of the election, plus all subsequent tax years. The election cannot be revoked without IRS consent."Originally posted by Deborah View Post
In other words, once you treat the interest as not being secured by your home, that treatment sticks. It won't revert to personal interest.
Business interest. Deductible.Comment
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Refinance
Luis, what if this loan were refinanced? Would the taxpayer then have the option of treating it as mortgage interest instead of business interest?
Note that the question is more theoretical than practical, as it would be hard to fathom how someone could save taxes doing this. (and justify paying closing costs for a new loan)Comment
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Unresearched, but I'd bet money that the interest retains it's character just as acquisition and equity interest do.Comment
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I agree. I'm sure it would fall into a category of allocating interest on a refinance based on the percentage of the new principal attributable to the old business principal. I don't believe a refinance would change the character.Originally posted by Davc View PostComment
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TTB, page 4-11 says the following:
Election to Treat Home Mortgage Interest as
Business Interest
A taxpayer can elect to treat debt secured by a home as not secured
by a home [Reg. ยง1.163-10T(o)(5)]. This election is advantageous
when home mortgage proceeds are used for business
purposes.
Looking at the example in the regulations cited by TTB, the example shows the taxpayer as having 3 different mortgages secured by a house. In the example, the third mortgage exceeds the debt limit for a home mortgage interest deduction due to it exceeding the FMV of the house reduced by acquisition debt. Since the taxpayer’s second mortgage can be traced to business debt, the taxpayer elects not to treat the second mortgage as home equity debt, thus freeing up the third mortgage for qualifying as home equity debt.
Since the example clearly illustrates how the election is a debt by debt election, and does not have to apply to all debt on the house, then we are talking about the election remaining in effect for as long as that particular debt is in existence. It is thus reasonable to assume that if that debt is ever refinanced, it is treated as a new debt, and the election would no longer apply, unless a new election is made and the refinanced debt could still be traced to business debt.
As was mentioned, however, I can’t think of any reason why you would want it deductible on Schedule A instead of Schedule C. Even if the business were to end, you can still deduct business interest on Schedule C, even if the Schedule C has no income.Comment
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Why? Your approach seems to imply that a refi repeals the tracing rules with regard to debt.Originally posted by Bees Knees View PostComment
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I stand corrected. IRS Pub 535, page 18 says:Originally posted by Davc View Post
Loan refinancing. Allocate the replacement
loan to the same uses to which the repaid loan
was allocated. Make the allocation only to the
extent you use the proceeds of the new loan to
repay any part of the original loan.
That means a refinanced loan does not repeal the tracing rules. It does not however, address the issue of whether you can cancel an election to treat mortgage debt as non-mortgage debt if that debt is ever refinanced. Reg. Sec. 1.163-10T(o)(5) is silent as to what happens if the debt is refinanced after the election is made. Therefore, there is no answer to this question, as you can't simply apply principals from one rule to the other as tax law is anything but consistent with itself.
Therefore, as Luis so eloquently put it, the proper answer to this question is: "I have no idea."Comment
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Let's assume that proceeds from the sale are at least as high as remaining mortgage. Wouldn't the taxpayer be obligated to use the money to repay and if t/p chooses not to use the proceeds it still would be deemed so? Meaning mortgage interest would need to be re-allocated because now it is personal use?Originally posted by Deborah View PostComment
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