Personal HELOC proceeds for business expenses

[David]

Client owns several S Corp businesses. He plans to get a HELOC against his house and use the proceeds for a build out for one of his businesses. He wants the business to pay the HELOC payments each month. I can't find anything in my research that would allow the business to deduct the interest on this HELOC. It wouldn't help if he was to "loan" the business the proceeds from his HELOC since the business would deduct interest expense but he would also report interest income on his personal return.

Any ideas?

Thanks.

[Lee B]

What your client should do to comply and substantiate the S Corp(s) interest deductions and maintain basis:

1.  Take out the HELOC with proceeds deposited in his personal checking account

2.  Loan the HELOC proceeds to the S Corp(s)

3.  Document the loans with the proper interest rates, repayment schedules etc.

4. Make sure that the S Corp(s) repay your client every month on schedule, issuing 1099INTs at the end of the year.

5. Your client should make all the HELOC repayments from his personal checking account.

Clients usually want to create shortcuts i.e., make it up as they go along ,which in your clients situation is a recipe for lost deductions etc., etc !

I will leave it to others to mention cites, case law etc.

[Abby Normal]

2 hours ago, cbslee said:

1.  Take out the HELOC with proceeds deposited in his personal checking account 

2.  Loan the HELOC proceeds to the S Corp(s) 

Well... under the new laws the HELOC would not be deductible on Sch A as mortgage interest, so having the corp deduct it and the shareholder show it as income on Sch B results in no deduction at all. You could argue for investment interest and deduct it there? I've seen some put on Sch E page 2 as business interest, but I'm not sure that's right either.

[Lee B]

25 minutes ago, Abby Normal said:

Well... under the new laws the HELOC would not be deductible on Sch A as mortgage interest, so having the corp deduct it and the shareholder show it as income on Sch B results in no deduction at all. You could argue for investment interest and deduct it there? I've seen some put on Sch E page 2 as business interest, but I'm not sure that's right either.

If the loan documentation/ substantiation isn't done then two more potential basis problems may arise.

1.  Additional loan basis will not be created potentially limiting future deduction of losses.

2.  If then client dumps the HELOC proceeds directly into the S Corp(s) without documentation and makes the HELOC repayments from the S Corp(s)

      then the HELOC repayments will be considered distribution of profits which will further reduce basis potentially limiting future deduction of losses.

The only way these S Corp(s) get a free and clear interest deduction is if the SCorp(s) are the borrowers.

[Roberts]

Yes you can use a HELOC as a business loan and it happens ALL THE TIME. When you do the first tax return with the debt, put a declaration in the interest paid showing exactly what you've done and make sure it is a loan on the books of the company. Tell the client to not mix the HELOC with personal funds. Also make sure the client realizes (I'm sure they do) that the loan is their personal responsibility in the end regardless of how they document it. Corporate bankruptcy doesn't get rid of the loan.

 

Many people (like me) use a cash out mortgage on their primary home to buy a rental property and then have the business pay off the mortgage. This has been talked about several times on this board over the years. The interest is then deducted on the Schedule E.

[jklcpa]

1 hour ago, Roberts said:

Yes you can use a HELOC as a business loan.

Tell the client to not mix the HELOC with personal funds. Also make sure the client realizes (I'm sure they do) that the loan is their personal responsibility in the end regardless of how they document it. Corporate bankruptcy doesn't get rid of the loan.

The interest is deducted on the Schedule E.

 

Yes, this is correct that it can be deductible on Schedule E. The default is that this borrowing would be considered "home equity debt" but may be uncoupled from that definition by "electing" to use the interest tracing rules.  That election is made by reporting it on Schedule E. 

I would strongly advise to NOT comingle the loan proceeds with other personal funds so to have a clear and unambiguous trail of use.

Reference is §1.163-10T(o)

[Roberts]

And with tracing rules, the source of the debt or the asset used as collateral doesn't really matter & it can be deducted on Schedule C also. As you say & I said - don't co-mingle a HELOC with personal funds if you want to do this.

 

If you take a cash advance on your credit card - it can be claimed to be a business debt if done properly. You had better show it properly and clearly in the accounting.

[David]

Thanks, everyone for your help with this.

I understand the Schedule E scenario. However, I wasn't sure about the S Corp scenario.

So if the loan proceeds are deposited into the S Corp bank account and the loan payments are paid by the S Corp, and interest is deducted by the S Corp, no problem?

I thought it would be a problem for the S Corp to make the loan payments since the loan is in the shareholder's name.

Thanks.

[Lion EA]

Re-read CB's posts.

[Lee B]

33 minutes ago, David said:

 

So if the loan proceeds are deposited into the S Corp bank account and the loan payments are paid by the S Corp, and interest is deducted by the S Corp, no problem?

I thought it would be a problem for the S Corp to make the loan payments since the loan is in the shareholder's name.

Did you read my first post ?

It is a big problem if you do it this way ! 

Unfortunately, there were several later posts that wandered off into the weeds and confused the issue.

[David]

Yes, CB I read your post and that was my initial understanding (see my original post). That strategy results in no net interest deduction since the S Corp interest deduction is offset by my client's interest income reported on his 1040.

I was trying to sum up what everyone said hoping that there was a strategy that others know about that I don't know. I guess there is no way a net interest deduction can be taken for this scenario. 

Thanks.

 

[Lee B]

As I posted before, the only way is if the S Corp borrows the funds directly in it's own name.