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Express 1040

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Express 1040

Express 1040 6. Express 1040   Insurance Table of Contents What's New Introduction Topics - This chapter discusses: Useful Items - You may want to see: Deductible PremiumsSelf-Employed Health Insurance Deduction Nondeductible Premiums Capitalized Premiums When To Deduct Premiums What's New Retiree drug subsidy. Express 1040  Beginning in 2013, sponsors of certain qualified retiree prescription drug plans must account for the subsidy received by reducing the amount of qualified retiree prescription drug plans expense by the subsidy received (taking into account the taxpayer's accounting method). Express 1040 For more information, see the retiree drug subsidy frequently asked questions on IRS. Express 1040 gov. Express 1040 Introduction You generally can deduct the ordinary and necessary cost of insurance as a business expense if it is for your trade, business, or profession. Express 1040 However, you may have to capitalize certain insurance costs under the uniform capitalization rules. Express 1040 For more information, see Capitalized Premiums , later. Express 1040 Topics - This chapter discusses: Deductible premiums Nondeductible premiums Capitalized premiums When to deduct premiums Useful Items - You may want to see: Publication 15-B Employer's Tax Guide to Fringe Benefits 525 Taxable and Nontaxable Income 538 Accounting Periods and Methods 547 Casualties, Disasters, and Thefts Form (and Instructions) 1040 U. Express 1040 S. Express 1040 Individual Income Tax Return See chapter 12 for information about getting publications and forms. Express 1040 Deductible Premiums You generally can deduct premiums you pay for the following kinds of insurance related to your trade or business. Express 1040 Insurance that covers fire, storm, theft, accident, or similar losses. Express 1040 Credit insurance that covers losses from business bad debts. Express 1040 Group hospitalization and medical insurance for employees, including long-term care insurance. Express 1040 If a partnership pays accident and health insurance premiums for its partners, it generally can deduct them as guaranteed payments to partners. Express 1040 If an S corporation pays accident and health insurance premiums for its more-than-2% shareholder-employees, it generally can deduct them, but must also include them in the shareholder's wages subject to federal income tax withholding. Express 1040 See Publication 15-B. Express 1040 Liability insurance. Express 1040 Malpractice insurance that covers your personal liability for professional negligence resulting in injury or damage to patients or clients. Express 1040 Workers' compensation insurance set by state law that covers any claims for bodily injuries or job-related diseases suffered by employees in your business, regardless of fault. Express 1040 If a partnership pays workers' compensation premiums for its partners, it generally can deduct them as guaranteed payments to partners. Express 1040 If an S corporation pays workers' compensation premiums for its more-than-2% shareholder-employees, it generally can deduct them, but must also include them in the shareholder's wages. Express 1040 Contributions to a state unemployment insurance fund are deductible as taxes if they are considered taxes under state law. Express 1040 Overhead insurance that pays for business overhead expenses you have during long periods of disability caused by your injury or sickness. Express 1040 Car and other vehicle insurance that covers vehicles used in your business for liability, damages, and other losses. Express 1040 If you operate a vehicle partly for personal use, deduct only the part of the insurance premium that applies to the business use of the vehicle. Express 1040 If you use the standard mileage rate to figure your car expenses, you cannot deduct any car insurance premiums. Express 1040 Life insurance covering your officers and employees if you are not directly or indirectly a beneficiary under the contract. Express 1040 Business interruption insurance that pays for lost profits if your business is shut down due to a fire or other cause. Express 1040 Self-Employed Health Insurance Deduction You may be able to deduct premiums paid for medical and dental insurance and qualified long-term care insurance for yourself, your spouse, and your dependents. Express 1040 The insurance can also cover your child who was under age 27 at the end of 2013, even if the child was not your dependent. Express 1040 A child includes your son, daughter, stepchild, adopted child, or foster child. Express 1040 A foster child is any child placed with you by an authorized placement agency or by judgment, decree, or other order of any court of competent jurisdiction. Express 1040 One of the following statements must be true. Express 1040 You were self-employed and had a net profit for the year reported on Schedule C (Form 1040), Profit or Loss From Business; Schedule C-EZ (Form 1040), Net Profit From Business; or Schedule F (Form 1040), Profit or Loss From Farming. Express 1040 You were a partner with net earnings from self-employment for the year reported on Schedule K-1 (Form 1065), Partner's Share of Income, Deductions, Credits, etc. Express 1040 , box 14, code A. Express 1040 You used one of the optional methods to figure your net earnings from self-employment on Schedule SE. Express 1040 You received wages in 2013 from an S corporation in which you were a more-than-2% shareholder. Express 1040 Health insurance premiums paid or reimbursed by the S corporation are shown as wages on Form W-2, Wage and Tax Statement. Express 1040 The insurance plan must be established, or considered to be established as discussed in the following bullets, under your business. Express 1040 For self-employed individuals filing a Schedule C, C-EZ, or F, a policy can be either in the name of the business or in the name of the individual. Express 1040 For partners, a policy can be either in the name of the partnership or in the name of the partner. Express 1040 You can either pay the premiums yourself or your partnership can pay them and report the premium amounts on Schedule K-1 (Form 1065) as guaranteed payments to be included in your gross income. Express 1040 However, if the policy is in your name and you pay the premiums yourself, the partnership must reimburse you and report the premium amounts on Schedule K-1 (Form 1065) as guaranteed payments to be included in your gross income. Express 1040 Otherwise, the insurance plan will not be considered to be established under your business. Express 1040 For more-than-2% shareholders, a policy can be either in the name of the S corporation or in the name of the shareholder. Express 1040 You can either pay the premiums yourself or your S corporation can pay them and report the premium amounts on Form W-2 as wages to be included in your gross income. Express 1040 However, if the policy is in your name and you pay the premiums yourself, the S corporation must reimburse you and report the premium amounts on Form W-2 as wages to be included in your gross income. Express 1040 Otherwise, the insurance plan will not be considered to be established under your business. Express 1040 Medicare premiums you voluntarily pay to obtain insurance in your name that is similar to qualifying private health insurance can be used to figure the deduction. Express 1040 If you previously filed returns without using Medicare premiums to figure the deduction, you can file timely amended returns to refigure the deduction. Express 1040 For more information, see Form 1040X, Amended U. Express 1040 S. Express 1040 Individual Income Tax Return. Express 1040 Amounts paid for health insurance coverage from retirement plan distributions that were nontaxable because you are a retired public safety officer cannot be used to figure the deduction. Express 1040 Take the deduction on Form 1040, line 29. Express 1040 Qualified long-term care insurance. Express 1040   You can include premiums paid on a qualified long-term care insurance contract when figuring your deduction. Express 1040 But, for each person covered, you can include only the smaller of the following amounts. Express 1040 The amount paid for that person. Express 1040 The amount shown below. Express 1040 Use the person's age at the end of the tax year. Express 1040 Age 40 or younger–$360 Age 41 to 50–$680 Age 51 to 60–$1,360 Age 61 to 70–$3,640 Age 71 or older–$4,550 Qualified long-term care insurance contract. Express 1040   A qualified long-term care insurance contract is an insurance contract that only provides coverage of qualified long-term care services. Express 1040 The contract must meet all the following requirements. Express 1040 It must be guaranteed renewable. Express 1040 It must provide that refunds, other than refunds on the death of the insured or complete surrender or cancellation of the contract, and dividends under the contract may be used only to reduce future premiums or increase future benefits. Express 1040 It must not provide for a cash surrender value or other money that can be paid, assigned, pledged, or borrowed. Express 1040 It generally must not pay or reimburse expenses incurred for services or items that would be reimbursed under Medicare, except where Medicare is a secondary payer or the contract makes per diem or other periodic payments without regard to expenses. Express 1040 Qualified long-term care services. Express 1040   Qualified long-term care services are: Necessary diagnostic, preventive, therapeutic, curing, treating, mitigating, and rehabilitative services, and Maintenance or personal care services. Express 1040 The services must be required by a chronically ill individual and prescribed by a licensed health care practitioner. Express 1040 Worksheet 6-A. Express 1040 Self-Employed Health Insurance Deduction Worksheet Note. Express 1040 Use a separate worksheet for each trade or business under which an insurance plan is established. Express 1040 1. Express 1040 Enter the total amount paid in 2013 for health insurance coverage established under your business for 2013 for you, your spouse, and your dependents. Express 1040 Your insurance can also cover your child who was under age 27 at the end of 2013, even if the child was not your dependent. Express 1040 But do not include the following. Express 1040   Amounts for any month you were eligible to participate in a health plan subsidized by your or your spouse's employer or the employer of either your dependent or your child who was under the age of 27 at the end of 2013. Express 1040 Any amounts paid from retirement plan distributions that were nontaxable because you are a retired public safety officer. Express 1040 Any amounts you included on Form 8885, line 4. Express 1040 Any qualified health insurance premiums you paid to “U. Express 1040 S. Express 1040 Treasury-HCTC. Express 1040 ” Any health coverage tax credit advance payments shown in box 1 of Form 1099-H. Express 1040 Any payments for qualified long-term care insurance (see line 2) 1. Express 1040   2. Express 1040 For coverage under a qualified long-term care insurance contract, enter for each person covered the smaller of the following amounts. Express 1040       a) Total payments made for that person during the year. Express 1040       b) The amount shown below. Express 1040 Use the person's age at the end of the tax year. Express 1040         $360— if that person is age 40 or younger          $680— if age 41 to 50         $1,360— if age 51 to 60         $3,640— if age 61 to 70         $4,550— if age 71 or older         Do not include payments for any month you were eligible to participate in a long-term care insurance plan subsidized by your or your spouse’s employer or the employer of either your dependent or your child who was under the age of 27 at the end of 2013. Express 1040 If more than one person is covered, figure separately the amount to enter for each person. Express 1040 Then enter the total of those amounts 2. Express 1040   3. Express 1040 Add lines 1 and 2 3. Express 1040   4. Express 1040 Enter your net profit* and any other earned income** from the trade or business under which the insurance plan is established. Express 1040 Do not include Conservation Reserve Program payments exempt from self-employment tax. Express 1040 If the business is an S corporation, skip to line 11 4. Express 1040   5. Express 1040 Enter the total of all net profits* from: Schedule C (Form 1040), line 31; Schedule C-EZ (Form 1040), line 3; Schedule F (Form 1040), line 34; or Schedule K-1 (Form 1065), box 14, code A; plus any other income allocable to the profitable businesses. Express 1040 Do not include Conservation Reserve Program payments exempt from self-employment tax. Express 1040 See the Instructions for Schedule SE (Form 1040). Express 1040 Do not include any net losses shown on these schedules. Express 1040 5. Express 1040   6. Express 1040 Divide line 4 by line 5 6. Express 1040   7. Express 1040 Multiply Form 1040, line 27, by the percentage on line 6 7. Express 1040   8. Express 1040 Subtract line 7 from line 4 8. Express 1040   9. Express 1040 Enter the amount, if any, from Form 1040, line 28, attributable to the same trade or business in which the insurance plan is established 9. Express 1040   10. Express 1040 Subtract line 9 from line 8 10. Express 1040   11. Express 1040 Enter your Medicare wages (Form W-2, box 5) from an S corporation in which you are a more-than-2% shareholder and in which the insurance plan is established 11. Express 1040   12. Express 1040 Enter any amount from Form 2555, line 45, attributable to the amount entered on line 4 or 11 above, or any amount from Form 2555-EZ, line 18, attributable to the amount entered on line 11 above 12. Express 1040   13. Express 1040 Subtract line 12 from line 10 or 11, whichever applies 13. Express 1040   14. Express 1040 Enter the smaller of line 3 or line 13 here and on Form 1040, line 29. Express 1040 Do not include this amount when figuring any medical expense deduction on Schedule A (Form 1040). Express 1040 14. Express 1040   * If you used either optional method to figure your net earnings from self-employment from any business, do not enter your net profit from the business. Express 1040 Instead, enter the amount attributable to that business from Schedule SE (Form 1040), Section B, line 4b. Express 1040 * *Earned income includes net earnings and gains from the sale, transfer, or licensing of property you created. Express 1040 However, it does not include capital gain income. Express 1040 Chronically ill individual. Express 1040   A chronically ill individual is a person who has been certified as one of the following. Express 1040 An individual who has been unable, due to loss of functional capacity for at least 90 days, to perform at least two activities of daily living without substantial assistance from another individual. Express 1040 Activities of daily living are eating, toileting, transferring (general mobility), bathing, dressing, and continence. Express 1040 An individual who requires substantial supervision to be protected from threats to health and safety due to severe cognitive impairment. Express 1040 The certification must have been made by a licensed health care practitioner within the previous 12 months. Express 1040 Benefits received. Express 1040   For information on excluding benefits you receive from a long-term care contract from gross income, see Publication 525. Express 1040 Other coverage. Express 1040   You cannot take the deduction for any month you were eligible to participate in any employer (including your spouse's) subsidized health plan at any time during that month, even if you did not actually participate. Express 1040 In addition, if you were eligible for any month or part of a month to participate in any subsidized health plan maintained by the employer of either your dependent or your child who was under age 27 at the end of 2013, do not use amounts paid for coverage for that month to figure the deduction. Express 1040   These rules are applied separately to plans that provide long-term care insurance and plans that do not provide long-term care insurance. Express 1040 However, any medical insurance payments not deductible on Form 1040, line 29, can be included as medical expenses on Schedule A (Form 1040), Itemized Deductions, if you itemize deductions. Express 1040 Effect on itemized deductions. Express 1040   Subtract the health insurance deduction from your medical insurance when figuring medical expenses on Schedule A (Form 1040) if you itemize deductions. Express 1040 Effect on self-employment tax. Express 1040   For tax years beginning before or after 2010, you cannot subtract the self-employed health insurance deduction when figuring net earnings for your self-employment tax from the business under which the insurance plan is established, or considered to be established as discussed earlier. Express 1040 For more information, see Schedule SE (Form 1040). Express 1040 How to figure the deduction. Express 1040   Generally, you can use the worksheet in the Form 1040 instructions to figure your deduction. Express 1040 However, if any of the following apply, you must use Worksheet 6-A in this chapter. Express 1040 You had more than one source of income subject to self-employment tax. Express 1040 You file Form 2555, Foreign Earned Income, or Form 2555-EZ, Foreign Earned Income Exclusion. Express 1040 You are using amounts paid for qualified long-term care insurance to figure the deduction. Express 1040 If you are claiming the health coverage tax credit, complete Form 8885, Health Coverage Tax Credit, before you figure this deduction. Express 1040 Health coverage tax credit. Express 1040   You may be able to take this credit only if you were an eligible trade adjustment assistance (TAA) recipient, alternative TAA (ATAA) recipient, reemployment trade adjustment assistance (RTAA) recipient, or Pension Benefit Guaranty Corporation (PBGC) pension recipient. Express 1040 Use Form 8885 to figure the amount, if any, of this credit. Express 1040   When figuring the amount to enter on line 1 of Worksheet 6-A, do not include the following. Express 1040 Any amounts you included on Form 8885, line 4. Express 1040 Any qualified health insurance premiums you paid to “U. Express 1040 S. Express 1040 Treasury-HCTC. Express 1040 ” Any health coverage tax credit advance payments shown in box 1 of Form 1099-H, Health Coverage Tax Credit (HCTC) Advance Payments. Express 1040 More than one health plan and business. Express 1040   If you have more than one health plan during the year and each plan is established under a different business, you must use separate worksheets (Worksheet 6-A) to figure each plan's net earnings limit. Express 1040 Include the premium you paid under each plan on line 1 or line 2 of that separate worksheet and your net profit (or wages) from that business on line 4 (or line 11). Express 1040 For a plan that provides long-term care insurance, the total of the amounts entered for each person on line 2 of all worksheets cannot be more than the appropriate limit shown on line 2 for that person. Express 1040 Nondeductible Premiums You cannot deduct premiums on the following kinds of insurance. Express 1040 Self-insurance reserve funds. Express 1040 You cannot deduct amounts credited to a reserve set up for self-insurance. Express 1040 This applies even if you cannot get business insurance coverage for certain business risks. Express 1040 However, your actual losses may be deductible. Express 1040 See Publication 547. Express 1040 Loss of earnings. Express 1040 You cannot deduct premiums for a policy that pays for lost earnings due to sickness or disability. Express 1040 However, see the discussion on overhead insurance, item (8), under Deductible Premiums , earlier. Express 1040 Certain life insurance and annuities. Express 1040 For contracts issued before June 9, 1997, you cannot deduct the premiums on a life insurance policy covering you, an employee, or any person with a financial interest in your business if you are directly or indirectly a beneficiary of the policy. Express 1040 You are included among possible beneficiaries of the policy if the policy owner is obligated to repay a loan from you using the proceeds of the policy. Express 1040 A person has a financial interest in your business if the person is an owner or part owner of the business or has lent money to the business. Express 1040 For contracts issued after June 8, 1997, you generally cannot deduct the premiums on any life insurance policy, endowment contract, or annuity contract if you are directly or indirectly a beneficiary. Express 1040 The disallowance applies without regard to whom the policy covers. Express 1040 Partners. Express 1040 If, as a partner in a partnership, you take out an insurance policy on your own life and name your partners as beneficiaries to induce them to retain their investments in the partnership, you are considered a beneficiary. Express 1040 You cannot deduct the insurance premiums. Express 1040 Insurance to secure a loan. Express 1040 If you take out a policy on your life or on the life of another person with a financial interest in your business to get or protect a business loan, you cannot deduct the premiums as a business expense. Express 1040 Nor can you deduct the premiums as interest on business loans or as an expense of financing loans. Express 1040 In the event of death, the proceeds of the policy are generally not taxed as income even if they are used to liquidate the debt. Express 1040 Capitalized Premiums Under the uniform capitalization rules, you must capitalize the direct costs and part of the indirect costs for certain production or resale activities. Express 1040 Include these costs in the basis of property you produce or acquire for resale, rather than claiming them as a current deduction. Express 1040 You recover the costs through depreciation, amortization, or cost of goods sold when you use, sell, or otherwise dispose of the property. Express 1040 Indirect costs include premiums for insurance on your plant or facility, machinery, equipment, materials, property produced, or property acquired for resale. Express 1040 Uniform capitalization rules. Express 1040   You may be subject to the uniform capitalization rules if you do any of the following, unless the property is produced for your use other than in a business or an activity carried on for profit. Express 1040 Produce real property or tangible personal property. Express 1040 For this purpose, tangible personal property includes a film, sound recording, video tape, book, or similar property. Express 1040 Acquire property for resale. Express 1040 However, these rules do not apply to the following property. Express 1040 Personal property you acquire for resale if your average annual gross receipts are $10 million or less for the 3 prior tax years. Express 1040 Property you produce if you meet either of the following conditions. Express 1040 Your indirect costs of producing the property are $200,000 or less. Express 1040 You use the cash method of accounting and do not account for inventories. Express 1040 More information. Express 1040   For more information on these rules, see Uniform Capitalization Rules in Publication 538 and the regulations under Internal Revenue Code section 263A. Express 1040 When To Deduct Premiums You can usually deduct insurance premiums in the tax year to which they apply. Express 1040 Cash method. Express 1040   If you use the cash method of accounting, you generally deduct insurance premiums in the tax year you actually paid them, even if you incurred them in an earlier year. Express 1040 However, see Prepayment , later. Express 1040 Accrual method. Express 1040   If you use an accrual method of accounting, you cannot deduct insurance premiums before the tax year in which you incur a liability for them. Express 1040 In addition, you cannot deduct insurance premiums before the tax year in which you actually pay them (unless the exception for recurring items applies). Express 1040 For more information about the accrual method of accounting, see chapter 1. Express 1040 For information about the exception for recurring items, see Publication 538. Express 1040 Prepayment. Express 1040   You cannot deduct expenses in advance, even if you pay them in advance. Express 1040 This rule applies to any expense paid far enough in advance to, in effect, create an asset with a useful life extending substantially beyond the end of the current tax year. Express 1040   Expenses such as insurance are generally allocable to a period of time. Express 1040 You can deduct insurance expenses for the year to which they are allocable. Express 1040 Example. Express 1040 In 2013, you signed a 3-year insurance contract. Express 1040 Even though you paid the premiums for 2013, 2014, and 2015 when you signed the contract, you can only deduct the premium for 2013 on your 2013 tax return. Express 1040 You can deduct in 2014 and 2015 the premium allocable to those years. Express 1040 Dividends received. Express 1040   If you receive dividends from business insurance and you deducted the premiums in prior years, at least part of the dividends generally are income. Express 1040 For more information, see Recovery of amount deducted (tax benefit rule) in chapter 1 under How Much Can I Deduct. Express 1040 Prev  Up  Next   Home   More Online Publications
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Understanding Your CP081 Notice

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The Express 1040

Express 1040 4. Express 1040   Interest Table of Contents Introduction Topics - This chapter discusses: Useful Items - You may want to see: Allocation of InterestOrder of funds spent. Express 1040 Payments from checking accounts. Express 1040 Amounts paid within 30 days. Express 1040 Optional method for determining date of reallocation. Express 1040 Interest on a segregated account. Express 1040 How to report. Express 1040 Interest You Can DeductStatement. Express 1040 Expenses paid to obtain a mortgage. Express 1040 Prepayment penalty. Express 1040 De minimis OID. Express 1040 Constant-yield method. Express 1040 Loan or mortgage ends. Express 1040 Interest You Cannot DeductPenalties. Express 1040 Who is a key person? Exceptions for pre-June 1997 contracts. Express 1040 Interest allocated to unborrowed policy cash value. Express 1040 Capitalization of Interest When To Deduct InterestPrepaid interest. Express 1040 Discounted loan. Express 1040 Refunds of interest. Express 1040 Prepaid interest. Express 1040 Discounted loan. Express 1040 Tax deficiency. Express 1040 Related person. Express 1040 Below-Market LoansLimit on forgone interest for gift loans of $100,000 or less. Express 1040 Introduction This chapter discusses the tax treatment of business interest expense. Express 1040 Business interest expense is an amount charged for the use of money you borrowed for business activities. Express 1040 Topics - This chapter discusses: Allocation of interest Interest you can deduct Interest you cannot deduct Capitalization of interest When to deduct interest Below-market loans Useful Items - You may want to see: Publication 537 Installment Sales 550 Investment Income and Expenses 936 Home Mortgage Interest Deduction Form (and Instructions) Sch A (Form 1040) Itemized Deductions Sch E (Form 1040) Supplemental Income and Loss Sch K-1 (Form 1065) Partner's Share of Income, Deductions, Credits, etc. Express 1040 Sch K-1 (Form 1120S) Shareholder's Share of Income, Deductions, Credits, etc. Express 1040 1098 Mortgage Interest Statement 3115 Application for Change in Accounting Method 4952 Investment Interest Expense Deduction 8582 Passive Activity Loss Limitations See chapter 12 for information about getting publications and forms. Express 1040 Allocation of Interest The rules for deducting interest vary, depending on whether the loan proceeds are used for business, personal, or investment activities. Express 1040 If you use the proceeds of a loan for more than one type of expense, you must allocate the interest based on the use of the loan's proceeds. Express 1040 Allocate your interest expense to the following categories. Express 1040 Nonpassive trade or business activity interest Passive trade or business activity interest Investment interest Portfolio interest Personal interest In general, you allocate interest on a loan the same way you allocate the loan proceeds. Express 1040 You allocate loan proceeds by tracing disbursements to specific uses. Express 1040 The easiest way to trace disbursements to specific uses is to keep the proceeds of a particular loan separate from any other funds. Express 1040 Secured loan. Express 1040   The allocation of loan proceeds and the related interest is not generally affected by the use of property that secures the loan. Express 1040 Example. Express 1040 You secure a loan with property used in your business. Express 1040 You use the loan proceeds to buy an automobile for personal use. Express 1040 You must allocate interest expense on the loan to personal use (purchase of the automobile) even though the loan is secured by business property. Express 1040    If the property that secures the loan is your home, you generally do not allocate the loan proceeds or the related interest. Express 1040 The interest is usually deductible as qualified home mortgage interest, regardless of how the loan proceeds are used. Express 1040 For more information, see Publication 936. Express 1040 Allocation period. Express 1040   The period for which a loan is allocated to a particular use begins on the date the proceeds are used and ends on the earlier of the following dates. Express 1040 The date the loan is repaid. Express 1040 The date the loan is reallocated to another use. Express 1040 Proceeds not disbursed to borrower. Express 1040   Even if the lender disburses the loan proceeds to a third party, the allocation of the loan is still based on your use of the funds. Express 1040 This applies whether you pay for property, services, or anything else by incurring a loan, or you take property subject to a debt. Express 1040 Proceeds deposited in borrower's account. Express 1040   Treat loan proceeds deposited in an account as property held for investment. Express 1040 It does not matter whether the account pays interest. Express 1040 Any interest you pay on the loan is investment interest expense. Express 1040 If you withdraw the proceeds of the loan, you must reallocate the loan based on the use of the funds. Express 1040 Example. Express 1040 Celina, a calendar-year taxpayer, borrows $100,000 on January 4 and immediately uses the proceeds to open a checking account. Express 1040 No other amounts are deposited in the account during the year and no part of the loan principal is repaid during the year. Express 1040 On April 2, Celina uses $20,000 from the checking account for a passive activity expenditure. Express 1040 On September 4, Celina uses an additional $40,000 from the account for personal purposes. Express 1040 Under the interest allocation rules, the entire $100,000 loan is treated as property held for investment for the period from January 4 through April 1. Express 1040 From April 2 through September 3, Celina must treat $20,000 of the loan as used in the passive activity and $80,000 of the loan as property held for investment. Express 1040 From September 4 through December 31, she must treat $40,000 of the loan as used for personal purposes, $20,000 as used in the passive activity, and $40,000 as property held for investment. Express 1040 Order of funds spent. Express 1040   Generally, you treat loan proceeds deposited in an account as used (spent) before either of the following amounts. Express 1040 Any unborrowed amounts held in the same account. Express 1040 Any amounts deposited after these loan proceeds. Express 1040 Example. Express 1040 On January 9, Olena opened a checking account, depositing $500 of the proceeds of Loan A and $1,000 of unborrowed funds. Express 1040 The following table shows the transactions in her account during the tax year. Express 1040 Date Transaction January 9 $500 proceeds of Loan A and $1,000 unborrowed funds deposited January 14 $500 proceeds of Loan B  deposited February 19 $800 used for personal purposes February 27 $700 used for passive activity June 19 $1,000 proceeds of Loan C  deposited November 20 $800 used for an investment December 18 $600 used for personal purposes Olena treats the $800 used for personal purposes as made from the $500 proceeds of Loan A and $300 of the proceeds of Loan B. Express 1040 She treats the $700 used for a passive activity as made from the remaining $200 proceeds of Loan B and $500 of unborrowed funds. Express 1040 She treats the $800 used for an investment as made entirely from the proceeds of Loan C. Express 1040 She treats the $600 used for personal purposes as made from the remaining $200 proceeds of Loan C and $400 of unborrowed funds. Express 1040 For the periods during which loan proceeds are held in the account, Olena treats them as property held for investment. Express 1040 Payments from checking accounts. Express 1040   Generally, you treat a payment from a checking or similar account as made at the time the check is written if you mail or deliver it to the payee within a reasonable period after you write it. Express 1040 You can treat checks written on the same day as written in any order. Express 1040 Amounts paid within 30 days. Express 1040   If you receive loan proceeds in cash or if the loan proceeds are deposited in an account, you can treat any payment (up to the amount of the proceeds) made from any account you own, or from cash, as made from those proceeds. Express 1040 This applies to any payment made within 30 days before or after the proceeds are received in cash or deposited in your account. Express 1040   If the loan proceeds are deposited in an account, you can apply this rule even if the rules stated earlier under Order of funds spent would otherwise require you to treat the proceeds as used for other purposes. Express 1040 If you apply this rule to any payments, disregard those payments (and the proceeds from which they are made) when applying the rules stated under Order of funds spent. Express 1040   If you received the loan proceeds in cash, you can treat the payment as made on the date you received the cash instead of the date you actually made the payment. Express 1040 Example. Express 1040 Giovanni gets a loan of $1,000 on August 4 and receives the proceeds in cash. Express 1040 Giovanni deposits $1,500 in an account on August 18 and on August 28 writes a check on the account for a passive activity expense. Express 1040 Also, Giovanni deposits his paycheck, deposits other loan proceeds, and pays his bills during the same period. Express 1040 Regardless of these other transactions, Giovanni can treat $1,000 of the deposit he made on August 18 as being paid on August 4 from the loan proceeds. Express 1040 In addition, Giovanni can treat the passive activity expense he paid on August 28 as made from the $1,000 loan proceeds treated as deposited in the account. Express 1040 Optional method for determining date of reallocation. Express 1040   You can use the following method to determine the date loan proceeds are reallocated to another use. Express 1040 You can treat all payments from loan proceeds in the account during any month as taking place on the later of the following dates. Express 1040 The first day of that month. Express 1040 The date the loan proceeds are deposited in the account. Express 1040 However, you can use this optional method only if you treat all payments from the account during the same calendar month in the same way. Express 1040 Interest on a segregated account. Express 1040   If you have an account that contains only loan proceeds and interest earned on the account, you can treat any payment from that account as being made first from the interest. Express 1040 When the interest earned is used up, any remaining payments are from loan proceeds. Express 1040 Example. Express 1040 You borrowed $20,000 and used the proceeds of this loan to open a new savings account. Express 1040 When the account had earned interest of $867, you withdrew $20,000 for personal purposes. Express 1040 You can treat the withdrawal as coming first from the interest earned on the account, $867, and then from the loan proceeds, $19,133 ($20,000 − $867). Express 1040 All the interest charged on the loan from the time it was deposited in the account until the time of the withdrawal is investment interest expense. Express 1040 The interest charged on the part of the proceeds used for personal purposes ($19,133) from the time you withdrew it until you either repay it or reallocate it to another use is personal interest expense. Express 1040 The interest charged on the loan proceeds you left in the account ($867) continues to be investment interest expense until you either repay it or reallocate it to another use. Express 1040 Loan repayment. Express 1040   When you repay any part of a loan allocated to more than one use, treat it as being repaid in the following order. Express 1040 Personal use. Express 1040 Investments and passive activities (other than those included in (3)). Express 1040 Passive activities in connection with a rental real estate activity in which you actively participate. Express 1040 Former passive activities. Express 1040 Trade or business use and expenses for certain low-income housing projects. Express 1040 Line of credit (continuous borrowings). Express 1040   The following rules apply if you have a line of credit or similar arrangement. Express 1040 Treat all borrowed funds on which interest accrues at the same fixed or variable rate as a single loan. Express 1040 Treat borrowed funds or parts of borrowed funds on which interest accrues at different fixed or variable rates as different loans. Express 1040 Treat these loans as repaid in the order shown on the loan agreement. Express 1040 Loan refinancing. Express 1040   Allocate the replacement loan to the same uses to which the repaid loan was allocated. Express 1040 Make the allocation only to the extent you use the proceeds of the new loan to repay any part of the original loan. Express 1040 Debt-financed distribution. Express 1040   A debt-financed distribution occurs when a partnership or S corporation borrows funds and allocates those funds to distributions made to partners or shareholders. Express 1040 The manner in which you report the interest expense associated with the distributed debt proceeds depends on your use of those proceeds. Express 1040 How to report. Express 1040   If the proceeds were used in a nonpassive trade or business activity, report the interest on Schedule E (Form 1040), line 28; enter “interest expense” and the name of the partnership or S corporation in column (a) and the amount in column (h). Express 1040 If the proceeds were used in a passive activity, follow the Instructions for Form 8582, Passive Activity Loss Limitations, to determine the amount of interest expense that can be reported on Schedule E (Form 1040), line 28; enter “interest expense” and the name of the partnership in column (a) and the amount in column (f). Express 1040 If the proceeds were used in an investment activity, enter the interest on Form 4952. Express 1040 If the proceeds are used for personal purposes, the interest is generally not deductible. Express 1040 Interest You Can Deduct You can generally deduct as a business expense all interest you pay or accrue during the tax year on debts related to your trade or business. Express 1040 Interest relates to your trade or business if you use the proceeds of the loan for a trade or business expense. Express 1040 It does not matter what type of property secures the loan. Express 1040 You can deduct interest on a debt only if you meet all the following requirements. Express 1040 You are legally liable for that debt. Express 1040 Both you and the lender intend that the debt be repaid. Express 1040 You and the lender have a true debtor-creditor relationship. Express 1040 Partial liability. Express 1040   If you are liable for part of a business debt, you can deduct only your share of the total interest paid or accrued. Express 1040 Example. Express 1040 You and your brother borrow money. Express 1040 You are liable for 50% of the note. Express 1040 You use your half of the loan in your business, and you make one-half of the loan payments. Express 1040 You can deduct your half of the total interest payments as a business deduction. Express 1040 Mortgage. Express 1040   Generally, mortgage interest paid or accrued on real estate you own legally or equitably is deductible. Express 1040 However, rather than deducting the interest currently, you may have to add it to the cost basis of the property as explained later under Capitalization of Interest. Express 1040 Statement. Express 1040   If you paid $600 or more of mortgage interest (including certain points) during the year on any one mortgage, you generally will receive a Form 1098 or a similar statement. Express 1040 You will receive the statement if you pay interest to a person (including a financial institution or a cooperative housing corporation) in the course of that person's trade or business. Express 1040 A governmental unit is a person for purposes of furnishing the statement. Express 1040   If you receive a refund of interest you overpaid in an earlier year, this amount will be reported in box 3 of Form 1098. Express 1040 You cannot deduct this amount. Express 1040 For information on how to report this refund, see Refunds of interest, later in this chapter. Express 1040 Expenses paid to obtain a mortgage. Express 1040   Certain expenses you pay to obtain a mortgage cannot be deducted as interest. Express 1040 These expenses, which include mortgage commissions, abstract fees, and recording fees, are capital expenses. Express 1040 If the property mortgaged is business or income-producing property, you can amortize the costs over the life of the mortgage. Express 1040 Prepayment penalty. Express 1040   If you pay off your mortgage early and pay the lender a penalty for doing this, you can deduct the penalty as interest. Express 1040 Interest on employment tax deficiency. Express 1040   Interest charged on employment taxes assessed on your business is deductible. Express 1040 Original issue discount (OID). Express 1040   OID is a form of interest. Express 1040 A loan (mortgage or other debt) generally has OID when its proceeds are less than its principal amount. Express 1040 The OID is the difference between the stated redemption price at maturity and the issue price of the loan. Express 1040   A loan's stated redemption price at maturity is the sum of all amounts (principal and interest) payable on it other than qualified stated interest. Express 1040 Qualified stated interest is stated interest that is unconditionally payable in cash or property (other than another loan of the issuer) at least annually over the term of the loan at a single fixed rate. Express 1040 You generally deduct OID over the term of the loan. Express 1040 Figure the amount to deduct each year using the constant-yield method, unless the OID on the loan is de minimis. Express 1040 De minimis OID. Express 1040   The OID is de minimis if it is less than one-fourth of 1% (. Express 1040 0025) of the stated redemption price of the loan at maturity multiplied by the number of full years from the date of original issue to maturity (the term of the loan). Express 1040   If the OID is de minimis, you can choose one of the following ways to figure the amount you can deduct each year. Express 1040 On a constant-yield basis over the term of the loan. Express 1040 On a straight-line basis over the term of the loan. Express 1040 In proportion to stated interest payments. Express 1040 In its entirety at maturity of the loan. Express 1040 You make this choice by deducting the OID in a manner consistent with the method chosen on your timely filed tax return for the tax year in which the loan is issued. Express 1040 Example. Express 1040 On January 1, 2013, you took out a $100,000 discounted loan and received $98,500 in proceeds. Express 1040 The loan will mature on January 1, 2023 (a 10-year term), and the $100,000 principal is payable on that date. Express 1040 Interest of $10,000 is payable on January 1 of each year, beginning January 1, 2014. Express 1040 The $1,500 OID on the loan is de minimis because it is less than $2,500 ($100,000 × . Express 1040 0025 × 10). Express 1040 You choose to deduct the OID on a straight-line basis over the term of the loan. Express 1040 Beginning in 2013, you can deduct $150 each year for 10 years. Express 1040 Constant-yield method. Express 1040   If the OID is not de minimis, you must use the constant-yield method to figure how much you can deduct each year. Express 1040 You figure your deduction for the first year using the following steps. Express 1040 Determine the issue price of the loan. Express 1040 Generally, this equals the proceeds of the loan. Express 1040 If you paid points on the loan (as discussed later), the issue price generally is the difference between the proceeds and the points. Express 1040 Multiply the result in (1) by the yield to maturity. Express 1040 Subtract any qualified stated interest payments from the result in (2). Express 1040 This is the OID you can deduct in the first year. Express 1040   To figure your deduction in any subsequent year, follow the above steps, except determine the adjusted issue price in step (1). Express 1040 To get the adjusted issue price, add to the issue price any OID previously deducted. Express 1040 Then follow steps (2) and (3) above. Express 1040   The yield to maturity is generally shown in the literature you receive from your lender. Express 1040 If you do not have this information, consult your lender or tax advisor. Express 1040 In general, the yield to maturity is the discount rate that, when used in computing the present value of all principal and interest payments, produces an amount equal to the principal amount of the loan. Express 1040 Example. Express 1040 The facts are the same as in the previous example, except that you deduct the OID on a constant yield basis over the term of the loan. Express 1040 The yield to maturity on your loan is 10. Express 1040 2467%, compounded annually. Express 1040 For 2013, you can deduct $93 [($98,500 × . Express 1040 102467) − $10,000]. Express 1040 For 2014, you can deduct $103 [($98,593 × . Express 1040 102467) − $10,000]. Express 1040 Loan or mortgage ends. Express 1040   If your loan or mortgage ends, you may be able to deduct any remaining OID in the tax year in which the loan or mortgage ends. Express 1040 A loan or mortgage may end due to a refinancing, prepayment, foreclosure, or similar event. Express 1040 If you refinance with the original lender, you generally cannot deduct the remaining OID in the year in which the refinancing occurs, but you may be able to deduct it over the term of the new mortgage or loan. Express 1040 See Interest paid with funds borrowed from original lender under Interest You Cannot Deduct, later. Express 1040 Points. Express 1040   The term “points” is used to describe certain charges paid, or treated as paid, by a borrower to obtain a loan or a mortgage. Express 1040 These charges are also called loan origination fees, maximum loan charges, discount points, or premium charges. Express 1040 If any of these charges (points) are solely for the use of money, they are interest. Express 1040   Because points are prepaid interest, you generally cannot deduct the full amount in the year paid. Express 1040 However, you can choose to fully deduct points in the year paid if you meet certain tests. Express 1040 For exceptions to the general rule, see Publication 936. Express 1040 The points reduce the issue price of the loan and result in original issue discount (OID), deductible as explained in the preceding discussion. Express 1040 Partial payments on a nontax debt. Express 1040   If you make partial payments on a debt (other than a debt owed the IRS), the payments are applied, in general, first to interest and any remainder to principal. Express 1040 You can deduct only the interest. Express 1040 This rule does not apply when it can be inferred that the borrower and lender understood that a different allocation of the payments would be made. Express 1040 Installment purchase. Express 1040   If you make an installment purchase of business property, the contract between you and the seller generally provides for the payment of interest. Express 1040 If no interest or a low rate of interest is charged under the contract, a portion of the stated principal amount payable under the contract may be recharacterized as interest (unstated interest). Express 1040 The amount recharacterized as interest reduces your basis in the property and increases your interest expense. Express 1040 For more information on installment sales and unstated interest, see Publication 537. Express 1040 Interest You Cannot Deduct Certain interest payments cannot be deducted. Express 1040 In addition, certain other expenses that may seem to be interest but are not, cannot be deducted as interest. Express 1040 You cannot currently deduct interest that must be capitalized, and you generally cannot deduct personal interest. Express 1040 Interest paid with funds borrowed from original lender. Express 1040   If you use the cash method of accounting, you cannot deduct interest you pay with funds borrowed from the original lender through a second loan, an advance, or any other arrangement similar to a loan. Express 1040 You can deduct the interest expense once you start making payments on the new loan. Express 1040   When you make a payment on the new loan, you first apply the payment to interest and then to the principal. Express 1040 All amounts you apply to the interest on the first loan are deductible, along with any interest you pay on the second loan, subject to any limits that apply. Express 1040 Capitalized interest. Express 1040   You cannot currently deduct interest you are required to capitalize under the uniform capitalization rules. Express 1040 See Capitalization of Interest, later. Express 1040 In addition, if you buy property and pay interest owed by the seller (for example, by assuming the debt and any interest accrued on the property), you cannot deduct the interest. Express 1040 Add this interest to the basis of the property. Express 1040 Commitment fees or standby charges. Express 1040   Fees you incur to have business funds available on a standby basis, but not for the actual use of the funds, are not deductible as interest payments. Express 1040 You may be able to deduct them as business expenses. Express 1040   If the funds are for inventory or certain property used in your business, the fees are indirect costs and you generally must capitalize them under the uniform capitalization rules. Express 1040 See Capitalization of Interest, later. Express 1040 Interest on income tax. Express 1040   Interest charged on income tax assessed on your individual income tax return is not a business deduction even though the tax due is related to income from your trade or business. Express 1040 Treat this interest as a business deduction only in figuring a net operating loss deduction. Express 1040 Penalties. Express 1040   Penalties on underpaid deficiencies and underpaid estimated tax are not interest. Express 1040 You cannot deduct them. Express 1040 Generally, you cannot deduct any fines or penalties. Express 1040 Interest on loans with respect to life insurance policies. Express 1040   You generally cannot deduct interest on a debt incurred with respect to any life insurance, annuity, or endowment contract that covers any individual unless that individual is a key person. Express 1040   If the policy or contract covers a key person, you can deduct the interest on up to $50,000 of debt for that person. Express 1040 However, the deduction for any month cannot be more than the interest figured using Moody's Composite Yield on Seasoned Corporate Bonds (formerly known as Moody's Corporate Bond Yield Average-Monthly Average Corporates) (Moody's rate) for that month. Express 1040 Who is a key person?   A key person is an officer or 20% owner. Express 1040 However, the number of individuals you can treat as key persons is limited to the greater of the following. Express 1040 Five individuals. Express 1040 The lesser of 5% of the total officers and employees of the company or 20 individuals. Express 1040 Exceptions for pre-June 1997 contracts. Express 1040   You can generally deduct the interest if the contract was issued before June 9, 1997, and the covered individual is someone other than an employee, officer, or someone financially interested in your business. Express 1040 If the contract was purchased before June 21, 1986, you can generally deduct the interest no matter who is covered by the contract. Express 1040 Interest allocated to unborrowed policy cash value. Express 1040   Corporations and partnerships generally cannot deduct any interest expense allocable to unborrowed cash values of life insurance, annuity, or endowment contracts. Express 1040 This rule applies to contracts issued after June 8, 1997, that cover someone other than an officer, director, employee, or 20% owner. Express 1040 For more information, see section 264(f) of the Internal Revenue Code. Express 1040 Capitalization of Interest Under the uniform capitalization rules, you generally must capitalize interest on debt equal to your expenditures to produce real property or certain tangible personal property. Express 1040 The property must be produced by you for use in your trade or business or for sale to customers. Express 1040 You cannot capitalize interest related to property that you acquire in any other manner. Express 1040 Interest you paid or incurred during the production period must be capitalized if the property produced is designated property. Express 1040 Designated property is any of the following. Express 1040 Real property. Express 1040 Tangible personal property with a class life of 20 years or more. Express 1040 Tangible personal property with an estimated production period of more than 2 years. Express 1040 Tangible personal property with an estimated production period of more than 1 year if the estimated cost of production is more than $1 million. Express 1040 Property you produce. Express 1040   You produce property if you construct, build, install, manufacture, develop, improve, create, raise, or grow it. Express 1040 Treat property produced for you under a contract as produced by you up to the amount you pay or incur for the property. Express 1040 Carrying charges. Express 1040   Carrying charges include taxes you pay to carry or develop real estate or to carry, transport, or install personal property. Express 1040 You can choose to capitalize carrying charges not subject to the uniform capitalization rules if they are otherwise deductible. Express 1040 For more information, see chapter 7. Express 1040 Capitalized interest. Express 1040   Treat capitalized interest as a cost of the property produced. Express 1040 You recover your interest when you sell or use the property. Express 1040 If the property is inventory, recover capitalized interest through cost of goods sold. Express 1040 If the property is used in your trade or business, recover capitalized interest through an adjustment to basis, depreciation, amortization, or other method. Express 1040 Partnerships and S corporations. Express 1040   The interest capitalization rules are applied first at the partnership or S corporation level. Express 1040 The rules are then applied at the partners' or shareholders' level to the extent the partnership or S corporation has insufficient debt to support the production or construction costs. Express 1040   If you are a partner or a shareholder, you may have to capitalize interest you incur during the tax year for the production costs of the partnership or S corporation. Express 1040 You may also have to capitalize interest incurred by the partnership or S corporation for your own production costs. Express 1040 To properly capitalize interest under these rules, you must be given the required information in an attachment to the Schedule K-1 you receive from the partnership or S corporation. Express 1040 Additional information. Express 1040   The procedures for applying the uniform capitalization rules are beyond the scope of this publication. Express 1040 For more information, see sections 1. Express 1040 263A-8 through 1. Express 1040 263A-15 of the regulations and Notice 88-99. Express 1040 Notice 88-99 is in Cumulative Bulletin 1988-2. Express 1040 When To Deduct Interest If the uniform capitalization rules, discussed under Capitalization of Interest, earlier, do not apply to you, deduct interest as follows. Express 1040 Cash method. Express 1040   Under the cash method, you can generally deduct only the interest you actually paid during the tax year. Express 1040 You cannot deduct a promissory note you gave as payment because it is a promise to pay and not an actual payment. Express 1040 Prepaid interest. Express 1040   You generally cannot deduct any interest paid before the year it is due. Express 1040 Interest paid in advance can be deducted only in the tax year in which it is due. Express 1040 Discounted loan. Express 1040   If interest or a discount is subtracted from your loan proceeds, it is not a payment of interest and you cannot deduct it when you get the loan. Express 1040 For more information, see Original issue discount (OID) under Interest You Can Deduct, earlier. Express 1040 Refunds of interest. Express 1040   If you pay interest and then receive a refund in the same tax year of any part of the interest, reduce your interest deduction by the refund. Express 1040 If you receive the refund in a later tax year, include the refund in your income to the extent the deduction for the interest reduced your tax. Express 1040 Accrual method. Express 1040   Under an accrual method, you can deduct only interest that has accrued during the tax year. Express 1040 Prepaid interest. Express 1040   See Prepaid interest, earlier. Express 1040 Discounted loan. Express 1040   See Discounted loan, earlier. Express 1040 Tax deficiency. Express 1040   If you contest a federal income tax deficiency, interest does not accrue until the tax year the final determination of liability is made. Express 1040 If you do not contest the deficiency, then the interest accrues in the year the tax was asserted and agreed to by you. Express 1040   However, if you contest but pay the proposed tax deficiency and interest, and you do not designate the payment as a cash bond, then the interest is deductible in the year paid. Express 1040 Related person. Express 1040   If you use an accrual method, you cannot deduct interest owed to a related person who uses the cash method until payment is made and the interest is includible in the gross income of that person. Express 1040 The relationship is determined as of the end of the tax year for which the interest would otherwise be deductible. Express 1040 See section 267 of the Internal Revenue Code for more information. Express 1040 Below-Market Loans If you receive a below-market gift or demand loan and use the proceeds in your trade or business, you may be able to deduct the forgone interest. Express 1040 See Treatment of gift and demand loans, later, in this discussion. Express 1040 A below-market loan is a loan on which no interest is charged or on which interest is charged at a rate below the applicable federal rate. Express 1040 A gift or demand loan that is a below-market loan generally is considered an arm's-length transaction in which you, the borrower, are considered as having received both the following. Express 1040 A loan in exchange for a note that requires the payment of interest at the applicable federal rate. Express 1040 An additional payment in an amount equal to the forgone interest. Express 1040 The additional payment is treated as a gift, dividend, contribution to capital, payment of compensation, or other payment, depending on the substance of the transaction. Express 1040 Forgone interest. Express 1040   For any period, forgone interest is The interest that would be payable for that period if interest accrued on the loan at the applicable federal rate and was payable annually on December 31, minus Any interest actually payable on the loan for the period. Express 1040 Applicable federal rates are published by the IRS each month in the Internal Revenue Bulletin. Express 1040 Internal Revenue Bulletins are available on the IRS web site at www. Express 1040 irs. Express 1040 gov/irb. Express 1040 You can also contact an IRS office to get these rates. Express 1040 Loans subject to the rules. Express 1040   The rules for below-market loans apply to the following. Express 1040 Gift loans (below-market loans where the forgone interest is in the nature of a gift). Express 1040 Compensation-related loans (below-market loans between an employer and an employee or between an independent contractor and a person for whom the contractor provides services). Express 1040 Corporation-shareholder loans. Express 1040 Tax avoidance loans (below-market loans where the avoidance of federal tax is one of the main purposes of the interest arrangement). Express 1040 Loans to qualified continuing care facilities under a continuing care contract (made after October 11, 1985). Express 1040   Except as noted in (5) above, these rules apply to demand loans (loans payable in full at any time upon the lender's demand) outstanding after June 6, 1984, and to term loans (loans that are not demand loans) made after that date. Express 1040 Treatment of gift and demand loans. Express 1040   If you receive a below-market gift loan or demand loan, you are treated as receiving an additional payment (as a gift, dividend, etc. Express 1040 ) equal to the forgone interest on the loan. Express 1040 You are then treated as transferring this amount back to the lender as interest. Express 1040 These transfers are considered to occur annually, generally on December 31. Express 1040 If you use the loan proceeds in your trade or business, you can deduct the forgone interest each year as a business interest expense. Express 1040 The lender must report it as interest income. Express 1040 Limit on forgone interest for gift loans of $100,000 or less. Express 1040   For gift loans between individuals, forgone interest treated as transferred back to the lender is limited to the borrower's net investment income for the year. Express 1040 This limit applies if the outstanding loans between the lender and borrower total $100,000 or less. Express 1040 If the borrower's net investment income is $1,000 or less, it is treated as zero. Express 1040 This limit does not apply to a loan if the avoidance of any federal tax is one of the main purposes of the interest arrangement. Express 1040 Treatment of term loans. Express 1040   If you receive a below-market term loan other than a gift or demand loan, you are treated as receiving an additional cash payment (as a dividend, etc. Express 1040 ) on the date the loan is made. Express 1040 This payment is equal to the loan amount minus the present value, at the applicable federal rate, of all payments due under the loan. Express 1040 The same amount is treated as original issue discount on the loan. Express 1040 See Original issue discount (OID) under Interest You Can Deduct, earlier. Express 1040 Exceptions for loans of $10,000 or less. Express 1040   The rules for below-market loans do not apply to any day on which the total outstanding loans between the borrower and lender is $10,000 or less. Express 1040 This exception applies only to the following. Express 1040 Gift loans between individuals if the loan is not directly used to buy or carry income-producing assets. Express 1040 Compensation-related loans or corporation-shareholder loans if the avoidance of any federal tax is not a principal purpose of the interest arrangement. Express 1040 This exception does not apply to a term loan described in (2) above that was previously subject to the below-market loan rules. Express 1040 Those rules will continue to apply even if the outstanding balance is reduced to $10,000 or less. Express 1040 Exceptions for loans without significant tax effect. Express 1040   The following loans are specifically exempted from the rules for below-market loans because their interest arrangements do not have a significant effect on the federal tax liability of the borrower or the lender. Express 1040 Loans made available by lenders to the general public on the same terms and conditions that are consistent with the lender's customary business practices. Express 1040 Loans subsidized by a federal, state, or municipal government that are made available under a program of general application to the public. Express 1040 Certain employee-relocation loans. Express 1040 Certain loans to or from a foreign person, unless the interest income would be effectively connected with the conduct of a U. Express 1040 S. Express 1040 trade or business and not exempt from U. Express 1040 S. Express 1040 tax under an income tax treaty. Express 1040 Any other loan if the taxpayer can show that the interest arrangement has no significant effect on the federal tax liability of the lender or the borrower. Express 1040 Whether an interest arrangement has a significant effect on the federal tax liability of the lender or the borrower will be determined by all the facts and circumstances. Express 1040 Consider all the following factors. Express 1040 Whether items of income and deduction generated by the loan offset each other. Express 1040 The amount of the items. Express 1040 The cost of complying with the below-market loan provisions if they were to apply. Express 1040 Any reasons, other than taxes, for structuring the transaction as a below-market loan. Express 1040 Exception for loans to qualified continuing care facilities. Express 1040   The below-market interest rules do not apply to a loan owed by a qualified continuing care facility under a continuing care contract if the lender or lender's spouse is age 62 or older by the end of the calendar year. Express 1040 A qualified continuing care facility is one or more facilities (excluding nursing homes) meeting the requirements listed below. Express 1040 Designed to provide services under continuing care contracts (defined below). Express 1040 Includes an independent living unit, and either an assisted living or nursing facility, or both. Express 1040 Substantially all of the independent living unit residents are covered by continuing care contracts. Express 1040 A continuing care contract is a written contract between an individual and a qualified continuing care facility that includes all of the following conditions. Express 1040 The individual or individual's spouse must be entitled to use the facility for the rest of their life or lives. Express 1040 The individual or individual's spouse will be provided with housing, as appropriate for the health of the individual or individual's spouse in an: independent living unit (which has additional available facilities outside the unit for the provision of meals and other personal care), and assisted living or nursing facility available in the continuing care facility. Express 1040 The individual or individual's spouse will be provided with assisted living or nursing care available in the continuing care facility, as required for the health of the individual or the individual's spouse. Express 1040 For more information, see section 7872(h) of the Internal Revenue Code. Express 1040 Sale or exchange of property. Express 1040   Different rules generally apply to a loan connected with the sale or exchange of property. Express 1040 If the loan does not provide adequate stated interest, part of the principal payment may be considered interest. Express 1040 However, there are exceptions that may require you to apply the below-market interest rate rules to these loans. Express 1040 See Unstated Interest and Original Issue Discount (OID) in Publication 537. Express 1040 More information. Express 1040   For more information on below-market loans, see section 7872 of the Internal Revenue Code and section 1. Express 1040 7872-5 of the regulations. Express 1040 Prev  Up  Next   Home   More Online Publications