Margaret CPA in OH Posted October 26, 2012 Report Share Posted October 26, 2012 I finally have all (I think!) the data from LLC and am going a bit crazy trying to figure this out. LLC bought Property A for cheap (cash, no mortgage), fixed up a lot and is renting. Then bought another property B by mortgaging Property A. That mortgage paid for B but cash out to LLC was 9.7%. B was inventory and then sold to son. My thought is that the mortgage interest payments to date of sale were all capitalized with inventory property but what about the 9.7% cash to LLC? And subsequent interest would be operating expense, correct? The cash was used for general purposes and (darn it!) they did not pay off the mortgage with the sale proceeds so a significant balance is outstanding. Thanks for direction. I think I will 'fire' this client after this. They keep shifting money from one to another of 5 accounts and tracing is making me crazy. Quote Link to comment Share on other sites More sharing options...
kcjenkins Posted October 28, 2012 Report Share Posted October 28, 2012 Step one, DOUBLE their fee. The interest on the 10% [rounding is appropriate here] would be operating expense, as will be all interest going forward. Quote Link to comment Share on other sites More sharing options...
jainen Posted October 28, 2012 Report Share Posted October 28, 2012 >>subsequent interest would be operating expense<< No! Interest tracing changes when the use of loan proceeds changes. 90.3% of the proceeds went to acquire Property B, but since they sold the property it now goes NOWHERE. Non-deductible. The 9.7% is deductible ONLY if it was used for a genuine business purpose, not distributed to partners through the LLC. "Cash out to LLC" doesn't necessarily suggest a business purpose. Quote Link to comment Share on other sites More sharing options...
Margaret CPA in OH Posted October 28, 2012 Author Report Share Posted October 28, 2012 Thanks to you both. There has, to date, been no cash out to the partners. The LLC owes so much money... The members will probably never see full repayment of all the funds they have loaned to the LLC for operations let alone the interest accrued on those loans. When I wrote 'cash out to the LLC', I meant that the LLC received some cash but it was not distributed to the partners. It went into the operations account. The other thought I had was that the entire mortgage proceeds be treated as operations funds with some/most going to the investment in the inventory of the subsequently sold property and the rest of the funds (not truly traceable, however) towards materials, subcontractors, etc. to make the property suitable for sale. But I then keep going back to what I know: the LLC bought this property with the mortgage proceeds on the one rental for the purpose of fixing up within the LLC then selling to the son of the members. So I know that the 90.3% (and maybe 100%) of the funds went to the purchase and remodeling of the inventory house. So tracing rules... I just wish they had paid the frikkin' mortgage off with the sale proceeds as they said they were going to do. There was certainly enough - $86,000+ for a $56,000 mortgage. But they didn't so I have this issue with the interest. jainen, I believe all the proceeds ultimately went to genuine business purposes. So that makes the remaining interest (following the sale of the inventoried house) deductible as operating expense, right? I have created classes of each property and a class for operations in QB (based on what they said were there business plans several years ago). Until the inventory sale, the mortgage payments were classed with that property. Now subsequent payments (principal and interest) go to operations? Retirement is lookin' really good now... Quote Link to comment Share on other sites More sharing options...
jainen Posted October 28, 2012 Report Share Posted October 28, 2012 >>subsequent payments (principal and interest) go to operations<< In my opinion, the interest is traced to an asset that they are no longer holding for a business purpose. I can see the argument for continuing to trace it to the proceeds of sale, but I don't agree. Other than the common misunderstanding that all mortgage interest is deductible, can you cite any authority? Nor can you allocate it to Cost of Goods Sold. The LLC does not seem to be in the business of repairing property for sale, but in any case real estate can never be inventory (by definition, even when held by a dealer). Besides, this transaction looks mighty personal--they drew on LLC assets to benefit a family member. Quote Link to comment Share on other sites More sharing options...
Margaret CPA in OH Posted October 28, 2012 Author Report Share Posted October 28, 2012 Thanks for more thought, jainen. No, I cannot cite any authority and am not averse to making the remaining interest nondeductible. The clients will be more than a bit dismayed, to be sure. The original business plan was, in fact, to purchase and fix up houses in challenged neighborhoods for resale. It happens that the first 3 properties wouldn't sell (market was already declining) so they rented those. This last one was purchased and fixed up then sold to son. I haven't asked whether that was the original intention (I suspect so but no proof). I was told that the plan was to pay off the mortgage with the sale proceeds and that didn't happen. The selling price is fair for the market, though. I don't believe there was a bargain price. They did gift equity of "$15,150 plus seller's concessions of $4033.81 but an earlier discussion on this board seemed to agree that this was not an issue - although it did increase the selling price listed by those amounts. Sorry I used the word 'inventory' in error. It was to distinguish this property from rental properties. If there is a better term, please let me know. If the interest to date of sale cannot/should not be capitalized as basis of the asset, is all the interest non-deductible for any purpose? That will be tough to explain when I am grasping already. Thanks again for the discussion and more to consider. Quote Link to comment Share on other sites More sharing options...
jainen Posted October 28, 2012 Report Share Posted October 28, 2012 >>That will be tough to explain<< Show them Chapter 4 of Pub 535. Tracing rules are the very first topic. "In general, you allocate interest on a loan the same way you allocate the loan proceeds. You allocate loan proceeds by tracing disbursements to specific uses." If they think that isn't technical enough, skip a few pages to the Capitalization rules. If they still don't trust you, go back to the last sentence of your original post. Quote Link to comment Share on other sites More sharing options...
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