John and Beth Harris formed a LLC. John has an HELOC under his name and wants to use it for their LLC for business use.
One of options John could have is, to lend his HELOC to their LLC. In this scenario, the LLC will issue a 1099 int to John and will report the 1099 amount as a business interest deduction on form 1065 when it files its tax return. As for John, he’ll receive a 1099 from their LLC as interest income and a 1098 from the bank where he took out his HELOC as interest expense. The couple will file a joint tax return and will not use itemized deduction, so where could John report these 2 items on his personal tax return, report both on his schedule C?
Thank you, BLL, for your reply. There is a “Choice to treat the debt as not secured by your home” (pub 936, page 2), and it says that “You may want to treat a debt as not secured by your home if the interest on that debt is fully deductible (for example, as a business expense)”. I believe John can take a full deduction for the interest, is my understanding correct?
John’s HELOC isn’t a business expense. It is an investment in the LLC using leveraged funds. The interest the LLC pays is deductible to it and it is considered interest income to John, but it will be a wash since the LLC is just a pass through entity. The interest John pays on the HELOC is income for the lender and deductible to him as investment interest or mortgage interest, both of which must be deducted on Schedule A.
See your point, BLL. Because the HELOC John lends to his LLC is treated as investment, therefore the interest the LLC pays to John is investment interest. Thanks a lot for your explanation.
My question now is, how John could possibly do to be able to let his HELOC for his LLC been treated as business fund, would it be fine if John uses his HELOC for his LLC as capital contribution? If that works, can John just takes out the HELOC proceed and transfers the fund to the LLC’s account, and then let the LLC make the monthly payment from its account and deduct the interest as a business interest expense on the LLC’s book? Any issues here, such as corporate and personal things are being ‘commingled’?
I’m not a big fan of loans between principals and entities, but that’s just me. If were John, I would take the HELOC money and use it as a capital contribution to the LLC. I have to defer to the CPAs for the specific tax treatment or provide a more tax efficient way to structure the deal.
Shareholders loan money to their business all the time. The issue is how to handle the deduction for the HELOC.
Option 1 (preferred). The LLC takes the interest deduction. John does not. It does not matter who receives a 1098. The IRS certainly won’t care if John fails to take a deduction he’s entitied to. Likewise, if the LLC is paying cash, they are entitled to a deduction, irrespective of who the check is written to.
This option does create comingling (the LLC is paying John’s personal bill and taking his personal deduction).
Option 2 (more hassle)
John is in the business of loaning money. that he is loaning money to an LLC that he is a member of is irrelevant.
He reports his interest income on Sch C, along with his interest expense for the HELOC. Normally, he should show more interest income than interest expense.
Also note that as a cash basis taxpayer, John will only have interest income if he actually receives interest payments from the LLC.
This avoids cominging, but is more of a hassle.
Probably a couple of other methods I could think of if I had more time…