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

Below are some of the more common questions and answers about Gift Tax issues. You may also find additional information in Publication 950 or some of the other forms and publications offered on our Forms Page. Included in this area are the instructions to Forms 706 and 709. Within these instructions, you will find the tax rate schedules to the related returns. If the answers to your questions can not be found in these resources, we strongly recommend visiting with a tax practitioner.


Who pays the gift tax?
The donor is generally responsible for paying the gift tax. Under special arrangements the donee may agree to pay the tax instead. Please visit with your tax professional if you are considering this type of arrangement.

What is considered a gift?
Any transfer to an individual, either directly or indirectly, where full consideration (measured in money or money's worth) is not received in return.

What can be excluded from gifts?
The general rule is that any gift is a taxable gift. However, there are many exceptions to this rule. Generally, the following gifts are not taxable gifts.

  1. Gifts that are not more than the annual exclusion for the calendar year.
  2. Tuition or medical expenses you pay for someone (the educational and medical exclusions).
  3. Gifts to your spouse.
  4. Gifts to a political organization for its use.

In addition to this, gifts to qualifying charities are deductible from the value of the gift(s) made.

May I deduct gifts on my income tax return?
Making a gift or leaving your estate to your heirs does not ordinarily affect your federal income tax. You cannot deduct the value of gifts you make (other than gifts that are deductible charitable contributions). If you are not sure whether the gift tax or the estate tax applies to your situation, refer to Publication 950, Introduction to Estate and Gift Taxes.

How many annual exclusions are available?
The annual exclusion applies to gifts to each donee. In other words, if you give each of your children $11,000 in 2002-2005, $12,000 in 2006-2008, $13,000 in 2009-2012 and $14,000 on or after January 1, 2013, the annual exclusion applies to each gift.

What if my spouse and I want to give away property that we own together?
You are each entitled to the annual exclusion amount on the gift. Together, you can give $22,000 to each donee (2002-2005) or $24,000 (2006-2008), $26,000 (2009-2012) and $28,000 on or after January 1, 2013.

What other information do I need to include with the return?
Refer to Form 709 (PDF), 709 Instructions and Publication 950. Among other items listed:

  1. Copies of appraisals.
  2. Copies of relevant documents regarding the transfer.
  3. Documentation of any unusual items shown on the return (partially-gifted assets, other items relevant to the transfer(s)).

What is "Fair Market Value?"
Fair Market Value is defined as: "The fair market value is the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts. The fair market value of a particular item of property includible in the decedent's gross estate is not to be determined by a forced sale price. Nor is the fair market value of an item of property to be determined by the sale price of the item in a market other than that in which such item is most commonly sold to the public, taking into account the location of the item wherever appropriate." Regulation §20.2031-1.

Who should I hire to represent me and prepare and file the return?
The Internal Revenue Service cannot make recommendations about specific individuals, but there are several factors to consider:

  1. How complex is the transfer?
  2. How large is the transfer?
  3. Do I need an attorney, CPA, Enrolled Agent (EA) or other professional(s)?

For most simple, small transfers (less than the annual exclusion amount) you may not need the services of a professional.

However, if the transfer is large or complicated or both, then these actions should be considered; It is a good idea to discuss the matter with several attorneys and CPAs or EAs. Ask about how much experience they have had and ask for referrals. This process should be similar to locating a good physician. Locate other individuals that have had similar experiences and ask for recommendations. Finally, after the individual(s) are employed and begin to work on transfer matters, make sure the lines of communication remain open so that there are no surprises.

Finally, people who make gifts as a part of their overall estate and financial plan often engage the services of both attorneys and CPAs, EAs and other professionals. The attorney usually handles wills, trusts and transfer documents that are involved and reviews the impact of documents on the gift tax return and overall plan. The CPA or EA often handles the actual return preparation and some representation of the donor in matters with the IRS. However, some attorneys handle all of the work. CPAs or EAs may also handle most of the work, but cannot take care of wills, trusts, deeds and other matters where a law license is required. In addition, other professionals (such as appraisers, surveyors, financial advisors and others) may need to be engaged during this time

Do I have to talk to the IRS during an examination?
You do not have to be present during an examination unless IRS representatives need to ask specific questions. Although you may represent yourself during an examination, most donors prefer that the professional(s) they have employed handle this phase of the examination. You may delegate authority for this by executing Form 2848 "Power of Attorney."

What if I disagree with the examination proposals?
You have many rights and avenues of appeal if you disagree with any proposals made by the IRS.  See Publications 1 and 5 (PDF) for an explanation of these options.

What if I sell property that has been given to me?
The general rule is that your basis in the property is the same as the basis of the donor. For example, if you were given stock that the donor had purchased for $10 per share (and that was his/her basis), and you later sold it for $100 per share, you would pay income tax on a gain of $90 per share. (Note: The rules are different for property acquired from an estate).

Most information for this page came from the Internal Revenue Code: Chapter 12--Gift Tax (generally Internal Revenue Code §2501 and following, related regulations and other sources)

Can a married same sex donor claim the gift tax marital deduction for a transfer to his or her spouse?
For federal tax purposes, the terms “spouse,” “husband,” and “wife” includes individuals of the same sex who were lawfully married under the laws of a state whose laws authorize the marriage of two individuals of the same sex and who remain married.  Also, the Service will recognize a marriage of individuals of the same sex that was validly created under the laws of the state of celebration even if the married couple resides in a state that does not recognize the validity of same-sex marriages.

However, the terms “spouse,” “husband and wife,” “husband,” and “wife” do not include individuals (whether of the opposite sex or the same sex) who have entered into a registered domestic partnership, civil union, or other similar formal relationship recognized under state law that is not denominated as a marriage under the laws of that state, and the term “marriage” does not include such formal relationships.

Gifts to your spouse are eligible for the marital deduction.

For further information, including the timeframes regarding filing claims or amended returns, see Revenue Ruling 2013-17.

Revenue Ruling 2013-17, along with updated Frequently Asked Questions for same-sex couples and updated FAQs for registered domestic partners and individuals in civil unions, are available today on IRS.gov. See also Publication 555, Community Property.


If you have suggestions or comments (or suggested FAQs) for the Estate and Gift Tax web site, please contact us: CONTACT ESTATE AND GIFT TAX.  We will not be able to respond to your email, but will consider it when making improvements or additions to this site.

Page Last Reviewed or Updated: 20-Feb-2014

The Free State Tax Filing Software

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