Deducting Business Interest Expenses on Your Taxes
Interest Expenses and Interest Income and Business Taxes
In most cases, interest is a deductible expense for your business. But there are some limitations and restrictions. How interest expenses depend on whether the expense is for a purchase of business property, on business debts (like credit card debt), or interest on investments. This article looks at both interest expenses and interest income and how they affect your business tax return.
Interest on Business Debts
Businesses may deduct interest on loans taken out for business, purposes, including mortgages on business property, term loans, and lines of credit.
The IRS says you may deduct interest on business loans if:
- You are legally liable for that debt. If you are audited, you will need to provide the paperwork to show the terms of the debt and the signatures. For example, a UCC-1 statement is often required on loans.
- Both you and the lender intend that the debt be repaid. You need to show that you are making payments and that the lender is depositing those payments. A person-to-person loan with no activity might be suspect.
- You and the lender have a true debtor-creditor relationship. That is, there is an arms-length transaction; it's not just you and your brother who loaned you money and doesn't want to be repaid.
Deducting Types of Business Interest Expenses
If your business borrows to purchase something, you will be charged interest on the balance.
Prepaid Interest. For mortgages on business property, you may end up prepaying interest from the settlement date to the closing date, as part of your closing costs.
The IRS says that when you prepay interest, you must allocate the interest over the tax years to which the interest applies. You may deduct in each year only the interest that applies to that year.
Interest expenses as part of cost of goods sold. Interest on purchases made on credit for inventory purchases should be included in your cost of goods sold calculations.
Investment interest expenses. Generally, your deduction for investment interest expense is limited to your net investment income. That is, the interest expense cannot be greater than the income generated from the investment. But, you may be able to carry over excess interest expenses to a future year's taxes.
William Perez, Tax Planning Expert, has more information on deducting business and personal investment interest.
You Cannot Deduct Capitalized Interest
You may not deduct interest that must be capitalized, that is, interest that is added to the principal balance of a loan or mortgage. This interest expenses must be depreciated along with the other costs of the business asset.
Business vs. Personal Interest Expenses
Interest expenses for personal loans are not deductible, except for mortgage loan interest. But if you have a loan for mixed business and personal expenses, you may deduct the portion that is for business purposes.
One specific instance of combined business and personal interest expenses deals with expenses for a home business. The business portion of home mortgage interest, as well as property taxes, is deductible as a business expense.
Where to Show these Expenses
- For sole proprietors and single-member LLCs, show these expenses in the "Expenses" section of Schedule C on Line 16. Note that interest expenses are divided between mortgage interest and all other interest expenses.
- For partnerships and multiple-member LLCs, show these expenses in the "Other Deductions" section of Form 1065
- For corporations, show these expenses in the "Other Deductions" section of Form 1120.
For More Information on Interest Income and Expenses
This article presents general information, and is not intended to be tax or legal advice; I am not a tax attorney or tax preparation specialist. Refer to IRS publications and discuss tax deductions with your professional tax advisor.