Loan Interest Expense Deduction for putting Money into Partnership

[VenuR]

My client has a one-third partnership interest in a Dialysis center and had to borrow from a bank for tenant improvements. She paid about $21,000 in interest for 2022. The income/loss is reported using Schedule E. How can she report & deduct the loan interest she paid to the bank on that loan?

Thanks.

[sjrcpa]

Your client paid for the partnership's improvements by borrowing money?

[VenuR]

Yes. That's correct. The bank sent the money to the partnership directly.

[sjrcpa]

How is the Partnership treating the loan funds from the bank on its Balance Sheet?

[VenuR]

The funds are used to pay for buying Dialysis chairs and equipment needed to run the Dialysis Center.

[sjrcpa]

When the partnership received the money, how did they record it on their books?

Loan from partner?

Capital contributed by partner?

C?

[VenuR]

There are 3 partners. Each one is a one-third share holder. Each one contributed one-third including the managing partner. It is a capital contribution, not a loan.

[Accountant-Man]

Bad bookkeeping for the p-ship. She will only be able to get the money back from the p-ship upon liquidation or sale.

It sounds like investment interest expense on her 1040, deductible on her Sch A only to the extent of investment income and then if she even itemizes.

[TaxGuyBill · Accepted solution]

Look at the Instructions for Schedule E, line 28, debt-financed acquisition.

https://www.irs.gov/instructions/i1040se#en_US_2022_publink24332td0e1965

[TaxGirl3]

When contributed as additional capital, interest is likely treated the same as the underlying activity (trade/business or passive).  See IRS Notice 89-35 and Reg §1.163-8T. 

FYI, a loan to the partnership would have meant that the interest would be investment interest. 

[VenuR]

Thank You TaxGuyBill for the help. I appreciate it.

[VenuR]

Thanks TaxGirl3 for the help in solving the problem. 

[larrygrussell1]

Hi VenuR.  I took your question to mean, exactly HOW IN LACERTE to report and deduct your partner's interest expense on her debt financed partnership capital contribution.

We have the (almost) exact situation.  My client, the Son, bought his Mothers shares in her SCorp.  Mom was the 100% owner.  Son signed a note payable to Mom and became the new 100% owner.

For Lacerte, we record the Son's SCorp K-1 as usual.  Then we record a second K-1 for that same SCorp (duplicating the same name, fein, etc) - and for the 2nd K-1 we enter the debt financed interest paid by the Son to the Mother as negative amount in "Ordinary business income (loss)".  We footnote that the second K-1 is the Debt Financed acquisition interest.

We have followed this procedure for years now and have no issues to date with the IRS.

[VenuR]

Thank You for your help in solving the problem.