Interest Expense SA.pdf

Interest Expense SA.pdf - SECTION XVI INTEREST EXPENSE...

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SECTION XVI INTEREST EXPENSE SUGGESTED ANALYSIS 1. Jim opened a $100,000 credit line at Credit Bank. He paid Credit Bank $50 to cover costs incurred in verifying his creditworthiness and $70 in document costs. Are any of these costs deductible under § 163? None of these costs constitute interest. Rev. Rul. 72-458, 1972-2 CB 514, citing Deputy v. Dupont, 308 U.S. 488 (1940), Ct. D. 1435, C.B. 1940-1, 118 2. Taxpayer borrowed $100,000 from Bank A on January 1 and deposited the funds into to a new non-interest bearing checking account. The activity in this checking account was as follows: 2/1 Paid $20,000 to buy a personal car 4/1 Paid $40,000 to buy office equipment for his business (non-passive) 6/1 Paid $30,000 for investment expenditure (non-passive) 8/1 Paid remaining $10,000 to invest in a passive activity How is the interest paid on this $100,000 loan allocated to the following categories: Personal debt; Investment debt; Trade or business debt; and Passive Activity debt? The classification of the loan interest expense depends upon the use to which the loan proceeds are put. When the funds are first deposited into the checking account, the funds are viewed as being used for investment. Therefore, initially all the interest expense on the debt is classified as investment interest. Temp. Treas. Reg. § 1.163-8T(c)(4)(i). Thereafter, the loan is reclassified depending on how the proceeds are spent and the interest on the loan is similarly reclassified. Once the $100,000 is fully spent, the character of the interest is generally fixed, until the loan is paid off.
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Transactions Personal Investment Trade or Business Passive 1/1 Deposit 100,000 2/1 Buy Car 20,0000 80,000 4/1 Office 20,000 40,000 40,000 6/1 Investment 20,000 40,000 40,000 8/1 Passive 20,000 30,000 40,000 10,000 This classification is important because trade or business interest is fully deductible § 162; investment interest is deductible only to the extent of net investment income §§ 163(d); 163(h)(2)(B); passive interest is subject to the passive loss rules and personal interest is not deductible at all § 163(h)(1). 3. How would your answer to Problem 2 change had the $10,000 investment made on 8/1 been for the purchase of tax exempt municipal bonds? The interest on the $10,000 loan used to purchase tax exempt municipal bonds would not be deductible. Interest on indebtedness incurred or continued to purchase or carry obligations the interest on which is wholly exempt from federal income taxation is not deductible. § 265(a)(2). See Treas. Reg. § 1.163-8T(m)(2)(i).
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4. Taxpayer borrowed $5,000 on January 1, 20X1 and deposited the proceeds in his regular checking account that already had a balance of $4,000 consisting of earned funds. He borrowed an additional $5,000 on February 11 and deposited them into the same account. All of his expenditures before January 1, 20X1 were for personal expenses. The activity in the account for January, February and March, 20X1 was as follows: 1/1 $4,000 Opening Balance 1/1 $5,000 Deposit of Borrowed Funds (balance $9,000) 1/13 $3,000 Personal expenditure (balance $6,000) 1/14 $6,000 Trade or business expense (balance $0) 2/11 $5,000 Deposit of Borrowed Funds (balance $5,000) 2/12 $3,000 Deposit of Salary (balance $8,000) 3/1 $4,000 Personal expenditure (balance $4,000) 3/2 $4,000
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