Morgage Interest paid by others

[Mai]

Hi,

A taxpayer plans to loan his line of credit ($300K to $500K) to a non-profit charity, which agree to pay for the morgage interest. How should this be handled and what's the tax consequence on both parties?

Option one: The taxpayer pay interest to the bank and the charity pay interest to the taxpayer at agreed rate. -> The taxpayer need to report the interest received (1099 from the charity) as misc income, and claim morgage interest on Sch A.

Option two: The charity pay the morgage interest to the bank direcly. The taxpayer doesn't report interest income, neither morgage interest even he has form 1098. The charity can still report the expense on their side.

I think option two is better, becasue there is no $100K loan limitation or phase out concern on the taxpayer side, but I am not sure if my assumption treatment is correct or if there is other option make more sense. Appreciate if someone can share their thoughts.

Thanks!

Mai

[Pacun]

If you prepare the taxes for the individual and not for the non-profit, you should advise your client to really think about what he is about to do. After careful consideration, he should say NO to non profit organization. If he goes against your advice, option 2 will be the best because it will be cleaner on his end. You are wrong on option 1, he will report interest received from non-profit as interest NOT as ordinary income since he is not in the business of lending money.

[TAXBILLY]

Hi,

A taxpayer plans to loan his line of credit ($300K to $500K) to a non-profit charity, which agree to pay for the morgage interest. How should this be handled and what's the tax consequence on both parties?

Option one: The taxpayer pay interest to the bank and the charity pay interest to the taxpayer at agreed rate. -> The taxpayer need to report the interest received (1099 from the charity) as misc income, and claim morgage interest on Sch A.

Option two: The charity pay the morgage interest to the bank direcly. The taxpayer doesn't report interest income, neither morgage interest even he has form 1098. The charity can still report the expense on their side.

I think option two is better, becasue there is no $100K loan limitation or phase out concern on the taxpayer side, but I am not sure if my assumption treatment is correct or if there is other option make more sense. Appreciate if someone can share their thoughts.

Thanks!

Mai

Option 2 creates reportable income to the client.

taxbilly

[Maribeth]

You need to split the transaction into its components and then go from there.

1. Your clients borrows on his line of credit. He then chooses to loan that money to the nonprofit, under a written note with stated terns. At this point, your client has incurred a debt of $xx and has received a contract receivable of $xx.

2. The nonprofit makes systematic payments on the contract receivable to your client. A portion of each payment is interest. The nonprofit has interest expense of $xx and your clients has interest income of $xx.

3. Your client makes systematic payments to the bank for the LOC. Your client has interest expense, some of which might not be deductible. See point #4.

4. On your client's tax return, your client will have interest income from the nonprofit. Your client will have investment interest expense for the amount of interest paid to the bank. Your client "should" be able to deduct this entire amount every year because the interest income received should equal the interest expense.

Maribeth

[Mai]

It seems a reasonable approach to report as Interest Income and Investment Expense. Thank you very much!!

[jainen]

>>split the transaction into its components<<

Once again I must caution against letting tax considerations overrule basic financial planning. For whatever reason, this organization can not convince normal lenders that it has the ability and/or intention to repay. Does the client really want to risk losing his HOME in that context? Maybe he could take a lien on the organization's assets in exchange for a personal guarantee on a loan they take out. Or something. For taxes interest expense will just offset interest income, so really that's not the most important thing.

[Mai]

I agree... However, the taxpayer has very strong belive in the charity organization per religion reason.