7934. How is interest traced to personal, investment, and passive activity expenditures?Nuco Employeercline202014-07-30T13:08:00Z2014-07-30T13:08:00Z49385347UMKC4412627314Site Map/General Income Taxation/Individuals/Deductions/Itemized/Interest/Investment InterestSite Map/Investments/Special Rules/Deduction of Interest and Expenses/Interest/Investment InterestTaxFactsDefaultArticle123351305-00-tf2.xml1305.00;#1738;#1953;#0x010100C568DB52D9D0A14D9B2FDCC96666E9F2007948130EC3DB064584E219954237AF3900242457EFB8B24247815D688C526CD44D009C4E67E972694125ABDA91AC61F5E51FTax Facts 2How is interest traced to personal, investment, and passive activity expenditures?
7300.00000000000TaxFactsDefaultArticleSBMEDIA\moss-admin2010-01-14T22:10:57Z7934. How is interest traced to personal, investment, and passive activity expenditures?Generally, the interest tracing rules allocate debt and the interest on it to expenditures according to the use of the debt proceeds. The deductibility of the interest is generally determined by the expenditure to which it is allocated. The allocation of interest under these rules is unaffected by the use of any asset or property to secure the debt; for example, interest on a debt traced to the purchase of an automobile will be personal interest even though the debt may be secured by shares of stock.Temp. Treas. Reg. §1.163-8T(c).Specific Ordering RulesThe tracing of debt proceeds is accomplished by specific rules that determine the order in which amounts borrowed are used. The allocation of debt under these specific ordering rules depends on the manner in which the debt proceeds are distributed to and held by the borrower. The following alternatives and results are described in regulations:(1) Proceeds are deposited in borrower’s account that also contains unborrowed funds: The first expenditures made from the account (with two exceptions) will be treated as made from the debt proceeds to the extent thereof. If proceeds from more than one debt are deposited, the funds will be considered expended in the order in which they were deposited. If they were deposited simultaneously, they will be treated as deposited in the order in which the debts were incurred.Temp. Treas. Reg. §1.163-8T(c)(4)(ii).Exceptions to this rule are: (a) any expenditure made from an account within the 30 days before or after the debt proceeds are deposited may be treated as made from the debt proceeds (to the extent thereof); and (b) if an account consists solely of debt proceeds and interest income on those proceeds, any expenditures from the account may be treated as first from the interest income, to the extent thereof at the time of the expenditure.Notice 89-35, 1989-1 CB 675.Example: Gladys purchases a certificate of deposit on May 1 for $3,000. On May 8 she borrows $5,000 and deposits it into her checking account, which also contains $5,000 of unborrowed funds. On May 21 she makes a down payment of $5,000 on a new car. On May 23 she invests $2,000 in stocks. Under rule (1), above, the debt proceeds (and interest thereon) would be traced to the car and characterized as personal interest; however, exception (a) permits Gladys to designate any expenditures during the 30 days before or after deposit as coming from the debt proceeds. Thus, Gladys may trace the debt to the purchase of the certificate of deposit and the stock, and thus determine the deductibility of her interest expense under the rules for investment interest.(2) Proceeds are disbursed to a third party: Expenditures directly to a person selling property or providing services to the borrower are treated as expenditures from the debt proceeds.Temp. Treas. Reg. §1.163-8T(c)(3)(i).(3) No disbursement is made: If the debt does not involve any cash disbursements (for example, the borrower is assuming a loan, or the seller is financing the purchase) the debt is treated as if the borrower had made an expenditure for the purpose to which the debt relates.Temp. Treas. Reg. §1.163-8T(c)(3)(ii).(4) Proceeds are disbursed to the borrower in cash: Any expenditure made within 30 days before or after the debt proceeds are received in cash may be treated as made from the debt proceeds. Otherwise, the debt will be treated as used for personal expenditures. If the proceeds are deposited into the borrower’s account and an expenditure is made from those proceeds (under the ordering rules described above) in the form of a cash withdrawal, the proceeds will be considered received in cash.Notice 89-35, 1989-1 CB 675.(5) Proceeds are held in an account: Debt proceeds are treated as held for investment purposes while held in an account, even if the account does not bear interest. When an expenditure is made, the debt is reallocated as described above. The taxpayer may either reallocate the debt on the date of the expenditure or on the first day of the month (or the date of deposit, if later than the first day of the month) so long as all expenditures from the account are treated similarly.Temp. Treas. Reg. §1.163-8T(c)(4)(i).Repayments and RefinancingsWhen a debt is allocable to more than one type of expenditure, repayments are applied in a manner that maximizes the deductibility of the remaining interest. Thus, for example, if a debt is allocated to personal, investment, and passive activity expenditures, repayment would be applied first against the portion attributable to the personal expenditure.Temp. Treas. Reg. §1.163-8T(d)(1). If a debt (including interest on it or borrowing charges other than interest) is repaid with the proceeds of a second debt, the second debt will be allocated to the same expenditures as the repaid debt.Temp. Treas. Reg. §1.163-8T(e). If, however, the amount of the second debt exceeds the amount of repayment, the excess will be allocated according to the normal allocation rules described above.Reallocation of DebtDebt that is allocated to an expenditure properly chargeable to a capital account with respect to an asset must be reallocated when the asset is sold or the nature of its use changes. For example, debt (and the interest on it) allocated to a computer purchased for business use must be reallocated to a personal expenditure if the computer is converted to personal use.Temp. Treas. Reg. §1.163-8T(j).Coordination with Other ProvisionsGenerally, any Internal Revenue Code provision that disallows, defers, or capitalizes an interest expense will be applied without regard to the expenditure to which the debt is allocated under these regulations, except that interest expense allocated to a personal expenditure is not capitalized.Temp. Treas. Reg. §1.163-8T(m)(2)(ii). For example, an interest expense on debt incurred or continued to purchase or carry tax-exempt obligations is not deductible regardless of the expenditure to which the debt is allocated under the regulations.Temp. Treas. Reg. §1.163-8T(m)(2)(i). Interest expense that is not deductible because of a deferral provision is taken into account as allocated, but is deferred to the year in which it becomes deductible. Thus, for example, interest on an amount borrowed by an accrual method taxpayer from a related cash basis taxpayer is deferred even though allocated to a passive activity expenditure. When the expense becomes deductible it will be allocated to the passive activity regardless of how it is allocated when it is no longer deferred.Temp. Treas. Reg. §1.163-8T(m)(6), Ex.(2).