||2008 Tax Year
This chapter discusses the tax treatment of business interest expense. Business interest expense is an amount charged for
the use of money you
borrowed for business activities.
Topics - This chapter discusses:
Useful Items - You may want to see:
Form (and Instructions)
Sch A (Form 1040)
Sch E (Form 1040)
Supplemental Income and Loss
Sch K-1 (Form 1065)
Partner's Share of Income, Deductions, Credits, etc.
Sch K-1 (Form 1120S)
Shareholder's Share of Income, Deductions, Credits, etc.
Mortgage Interest Statement
Application for Change in Accounting Method
Investment Interest Expense Deduction
Passive Activity Loss Limitations
See chapter 12 for information about getting publications and forms.
The rules for deducting interest vary, depending on whether the loan proceeds are used for business, personal, or investment
activities. If you use
the proceeds of a loan for more than one type of expense, you must make an allocation to determine the interest for each use
of the loan's proceeds.
Allocate your interest expense to the following categories.
In general, you allocate interest on a loan the same way you allocate the loan proceeds. You allocate loan proceeds by tracing
The easiest way to trace disbursements to specific uses is to keep the proceeds of a particular loan separate from any other
The allocation of loan proceeds and the related interest is not generally affected by the use of property that secures
You secure a loan with property used in your business. You use the loan proceeds to buy an automobile for personal use. You
must allocate interest
expense on the loan to personal use (purchase of the automobile) even though the loan is secured by business property.
If the property that secures the loan is your home, you generally do not allocate the loan proceeds or the related interest.
The interest is
usually deductible as qualified home mortgage interest, regardless of how the loan proceeds are used. For more information,
see Publication 936.
The period for which a loan is allocated to a particular use begins on the date the proceeds are used and ends on
the earlier of the following
Proceeds not disbursed to borrower.
Even if the lender disburses the loan proceeds to a third party, the allocation of the loan is still based on your
use of the funds. This applies
whether you pay for property, services, or anything else by incurring a loan, or you take property subject to a debt.
Proceeds deposited in borrower's account.
Treat loan proceeds deposited in an account as property held for investment. It does not matter whether the account
pays interest. Any interest you
pay on the loan is investment interest expense. If you withdraw the proceeds of the loan, you must reallocate the loan based
on the use of the funds.
Connie, a calendar-year taxpayer, borrows $100,000 on January 4 and immediately uses the proceeds to open a checking account.
No other amounts are
deposited in the account during the year and no part of the loan principal is repaid during the year. On April 2, Connie uses
$20,000 from the
checking account for a passive activity expenditure. On September 4, Connie uses an additional $40,000 from the account for
Under the interest allocation rules, the entire $100,000 loan is treated as property held for investment for the period from
January 4 through
April 1. From April 2 through September 3, Connie must treat $20,000 of the loan as used in the passive activity and $80,000
of the loan as property
held for investment. From September 4 through December 31, she must treat $40,000 of the loan as used for personal purposes,
$20,000 as used in the
passive activity, and $40,000 as property held for investment.
Order of funds spent.
Generally, you treat loan proceeds deposited in an account as used (spent) before either of the following amounts.
On January 9, Edith opened a checking account, depositing $500 of the proceeds of Loan A and $1,000 of unborrowed funds. The
following table shows
the transactions in her account during the tax year.
$500 proceeds of Loan A and
$1,000 unborrowed funds
$500 proceeds of Loan B
$800 used for personal purposes
$700 used for passive activity
$1,000 proceeds of Loan C
$800 used for an investment
$600 used for personal purposes
Edith treats the $800 used for personal purposes as made from the $500 proceeds of Loan A and $300 of the proceeds of Loan
B. She treats the $700
used for a passive activity as made from the remaining $200 proceeds of Loan B and $500 of unborrowed funds. She treats the
$800 used for an
investment as made entirely from the proceeds of Loan C. She treats the $600 used for personal purposes as made from the remaining
$200 proceeds of
Loan C and $400 of unborrowed funds.
For the periods during which loan proceeds are held in the account, Edith treats them as property held for investment.
Payments from checking accounts.
Generally, you treat a payment from a checking or similar account as made at the time the check is written if you
mail or deliver it to the payee
within a reasonable period after you write it. You can treat checks written on the same day as written in any order.
Amounts paid within 30 days.
If you receive loan proceeds in cash or if the loan proceeds are deposited in an account, you can treat any payment
(up to the amount of the
proceeds) made from any account you own, or from cash, as made from those proceeds. This applies to any payment made within
30 days before or after
the proceeds are received in cash or deposited in your account.
If the loan proceeds are deposited in an account, you can apply this rule even if the rules stated earlier under Order of funds spent
would otherwise require you to treat the proceeds as used for other purposes. If you apply this rule to any payments, disregard
(and the proceeds from which they are made) when applying the rules stated under Order of funds spent.
If you received the loan proceeds in cash, you can treat the payment as made on the date you received the cash instead
of the date you actually
made the payment.
Frank gets a loan of $1,000 on August 4 and receives the proceeds in cash. Frank deposits $1,500 in an account on August 18
and on August 28 writes
a check on the account for a passive activity expense. Also, Frank deposits his paycheck, deposits other loan proceeds, and
pays his bills during the
same period. Regardless of these other transactions, Frank can treat $1,000 of the deposit he made on August 18 as being paid
on August 4 from the
loan proceeds. In addition, Frank can treat the passive activity expense he paid on August 28 as made from the $1,000 loan
proceeds treated as
deposited in the account.
Optional method for determining date of reallocation.
You can use the following method to determine the date loan proceeds are reallocated to another use. You can treat
all payments from loan proceeds
in the account during any month as taking place on the later of the following dates.
However, you can use this optional method only if you treat all payments from the account during the same calendar month in
the same way.
Interest on a segregated account.
If you have an account that contains only loan proceeds and interest earned on the account, you can treat any payment
from that account as being
made first from the interest. When the interest earned is used up, any remaining payments are from loan proceeds.
You borrowed $20,000 and used the proceeds of this loan to open a new savings account. When the account had earned interest
of $867, you withdrew
$20,000 for personal purposes. You can treat the withdrawal as coming first from the interest earned on the account, $867,
and then from the loan
proceeds, $19,133 ($20,000 - $867). All the interest charged on the loan from the time it was deposited in the account until
the time of the
withdrawal is investment interest expense. The interest charged on the part of the proceeds used for personal purposes ($19,133)
from the time you
withdrew it until you either repay it or reallocate it to another use is personal interest expense. The interest charged on
the loan proceeds you left
in the account ($867) continues to be investment interest expense until you either repay it or reallocate it to another use.
When you repay any part of a loan allocated to more than one use, treat it as being repaid in the following order.
Investments and passive activities (other than those included in (3)).
Passive activities in connection with a rental real estate activity in which you actively participate.
Former passive activities.
Trade or business use and expenses for certain low-income housing projects.
Line of credit (continuous borrowings).
The following rules apply if you have a line of credit or similar arrangement.
Treat all borrowed funds on which interest accrues at the same fixed or variable rate as a single loan.
Treat borrowed funds or parts of borrowed funds on which interest accrues at different fixed or variable rates as different
these loans as repaid in the order shown on the loan agreement.
Allocate the replacement loan to the same uses to which the repaid loan was allocated. Make the allocation only to
the extent you use the proceeds
of the new loan to repay any part of the original loan.
A debt-financed distribution occurs when a partnership or S corporation borrows funds and allocates those funds to
distributions made to partners
or shareholders. The manner in which you report the interest expense associated with the distributed debt proceeds depends
on your use of those
How to report.
If the proceeds were used in a nonpassive trade or business activity, report the interest on Schedule E (Form 1040),
line 28; enter “interest
” and the name of the partnership or S corporation in column (a) and the amount in column (h). If the proceeds were used in
activity, follow the instructions for Form 8582, Passive Activity Loss Limitations, to determine the amount of interest expense
that can be reported
on Schedule E (Form 1040), line 28; enter “interest expense
” and the name of the partnership in column (a) and the amount in column (f). If the
proceeds were used in an investment activity, enter the interest on Form 4952. If the proceeds are used for personal purposes,
the interest is
generally not deductible.
You can generally deduct as a business expense all interest you pay or accrue during the tax year on debts related to your
trade or business.
Interest relates to your trade or business if you use the proceeds of the loan for a trade or business expense. It does not
matter what type of
property secures the loan. You can deduct interest on a debt only if you meet all the following requirements.
You are legally liable for that debt.
Both you and the lender intend that the debt be repaid.
You and the lender have a true debtor-creditor relationship.
If you are liable for part of a business debt, you can deduct only your share of the total interest paid or accrued.
You and your brother borrow money. You are liable for 50% of the note. You use your half of the loan in your business, and
you make one-half of the
loan payments. You can deduct your half of the total interest payments as a business deduction.
Generally, mortgage interest paid or accrued on real estate you own legally or equitably is deductible. However, rather
than deducting the interest
currently, you may have to add it to the cost basis of the property as explained later under Capitalization of Interest.
If you paid $600 or more of mortgage interest (including certain points) during the year on any one mortgage, you
generally will receive a Form
or a similar statement. You will receive the statement if you pay interest to a person (including a financial
institution or a cooperative housing corporation) in the course of that person's trade or business. A governmental unit is
a person for purposes of
furnishing the statement.
If you receive a refund of interest you overpaid in an earlier year, this amount will be reported in box 3 of Form
1098. You cannot deduct this
amount. For information on how to report this refund, see Refunds of interest
later in this chapter.
Expenses paid to obtain a mortgage.
Certain expenses you pay to obtain a mortgage cannot be deducted as interest. These expenses, which include mortgage
commissions, abstract fees,
and recording fees, are capital expenses. If the property mortgaged is business or income-producing property, you can amortize
the costs over the life
of the mortgage.
If you pay off your mortgage early and pay the lender a penalty for doing this, you can deduct the penalty as interest.
Interest on employment tax deficiency.
Interest charged on employment taxes assessed on your business is deductible.
Original issue discount (OID).
OID is a form of interest. A loan (mortgage or other debt) generally has OID when its proceeds are less than its principal
amount. The OID is the
difference between the stated redemption price at maturity and the issue price of the loan.
A loan's stated redemption price at maturity is the sum of all amounts (principal and interest) payable on it other
than qualified stated
interest. Qualified stated interest is stated interest that is unconditionally payable in cash or property (other than another
loan of the issuer) at
least annually over the term of the loan at a single fixed rate.
You generally deduct OID over the term of the loan. Figure the amount to deduct each year using the constant-yield method,
unless the OID on the
loan is de minimis.
De minimis OID.
The OID is de minimis if it is less than one-fourth of 1% (.0025) of the stated redemption price of the loan at maturity
multiplied by the number
of full years from the date of original issue to maturity (the term of the loan).
If the OID is de minimis, you can choose one of the following ways to figure the amount you can deduct each year.
On a constant-yield basis over the term of the loan.
On a straight-line basis over the term of the loan.
In proportion to stated interest payments.
In its entirety at maturity of the loan.
You make this choice by deducting the OID in a manner consistent with the method chosen on your timely filed tax return for
the tax year in
which the loan is issued.
On January 1, 2007, you took out a $100,000 discounted loan and received $98,500 in proceeds. The loan will mature on January
1, 2017 (a 10-year
term), and the $100,000 principal is payable on that date. Interest of $10,000 is payable on January 1 of each year, beginning
January 1, 2008. The
$1,500 OID on the loan is de minimis because it is less than $2,500 ($100,000 × .0025 × 10). You choose to deduct the OID
straight-line basis over the term of the loan. Beginning in 2007, you can deduct $150 each year for 10 years.
If the OID is not de minimis, you must use the constant-yield method to figure how much you can deduct each year.
You figure your deduction for the
first year using the following steps.
Determine the issue price of the loan. Generally, this equals the proceeds of the loan. If you paid points on the loan (as
the issue price generally is the difference between the proceeds and the points.
Multiply the result in (1) by the yield to maturity.
Subtract any qualified stated interest payments from the result in (2). This is the OID you can deduct in the first year.
To figure your deduction in any subsequent year, follow the above steps, except determine the adjusted issue price
in step (1). To get the adjusted
issue price, add to the issue price any OID previously deducted. Then follow steps (2) and (3) above.
The yield to maturity is generally shown in the literature you receive from your lender. If you do not have this information,
consult your lender
or tax advisor. In general, the yield to maturity is the discount rate that, when used in computing the present value of all
principal and interest
payments, produces an amount equal to the principal amount of the loan.
The facts are the same as in the previous example, except that you deduct the OID on a constant yield basis over the term
of the loan. The yield to
maturity on your loan is 10.2467%, compounded annually. For 2007, you can deduct $93 [($98,500 × .102467) - $10,000]. For
2008, you can
deduct $103 [($98,593 × .102467) - $10,000].
Loan or mortgage ends.
If your loan or mortgage ends, you may be able to deduct any remaining OID in the tax year in which the loan or mortgage
ends. A loan or mortgage
may end due to a refinancing, prepayment, foreclosure, or similar event.
If you refinance with the original lender, you generally cannot deduct the remaining OID in the year in which the refinancing
occurs, but you may
be able to deduct it over the term of the new mortgage or loan. See Interest paid with funds borrowed from original lender
Interest You Cannot Deduct, later.
The term “points
” is used to describe certain of the charges paid, or treated as paid, by a borrower to obtain a loan or a mortgage. These
charges are also called loan origination fees, maximum loan charges, discount points, or premium charges. If any of these
charges (points) are solely
for the use of money, they are interest.
Because points are prepaid interest, you generally cannot deduct the full amount in the year paid. However, you can
choose to fully deduct points
in the year paid if you meet certain tests. For exceptions to the general rule, see Publication 936.
The points reduce the issue price of the loan and result in original issue discount, deductible as explained in the preceding
Partial payments on a nontax debt.
If you make partial payments on a debt (other than a debt owed the IRS), the payments are applied, in general, first
to interest and any remainder
to principal. You can deduct only the interest. This rule does not apply when it can be inferred that the borrower and lender
understood that a
different allocation of the payments would be made.
If you make an installment purchase of business property, the contract between you and the seller generally provides
for the payment of interest.
If no interest or a low rate of interest is charged under the contract, a portion of the stated principal amount payable under
the contract may be
recharacterized as interest (unstated interest). The amount recharacterized as interest reduces your basis in the property
and increases your interest
expense. For more information on installment sales and unstated interest, see Publication 537.
Interest You Cannot Deduct
Certain interest payments cannot be deducted. In addition, certain other expenses that may seem to be interest are not, and
you cannot deduct them
You cannot currently deduct interest that must be capitalized, and you generally cannot deduct personal interest.
Interest paid with funds borrowed from original lender.
If you use the cash method of accounting, you cannot deduct interest you pay with funds borrowed from the original
lender through a second loan, an
advance, or any other arrangement similar to a loan. You can deduct the interest expense once you start making payments on
the new loan.
When you make a payment on the new loan, you first apply the payment to interest and then to the principal. All amounts
you apply to the interest
on the first loan are deductible, along with any interest you pay on the second loan, subject to any limits that apply.
You cannot currently deduct interest you are required to capitalize under the uniform capitalization rules. See Capitalization of Interest,
later. In addition, if you buy property and pay interest owed by the seller (for example, by assuming the debt and any interest
accrued on the
property), you cannot deduct the interest. Add this interest to the basis of the property.
Commitment fees or standby charges.
Fees you incur to have business funds available on a standby basis, but not for the actual use of the funds, are not
deductible as interest
payments. You may be able to deduct them as business expenses.
If the funds are for inventory or certain property used in your business, the fees are indirect costs and you generally
must capitalize them under
the uniform capitalization rules. See Capitalization of Interest,
Interest on income tax.
Interest charged on income tax assessed on your individual income tax return is not a business deduction even though
the tax due is related to
income from your trade or business. Treat this interest as a business deduction only in figuring a net operating loss deduction.
Penalties on underpaid deficiencies and underpaid estimated tax are not interest. You cannot deduct them. Generally,
you cannot deduct any fines or
Interest on loans with respect to life insurance policies.
You generally cannot deduct interest on a debt incurred with respect to any life insurance, annuity, or endowment
contract that covers any
individual unless that individual is a key person.
If the policy or contract covers a key person, you can deduct the interest on up to $50,000 of debt for that person.
However, the deduction for any
month cannot be more than the interest figured using Moody's Composite Yield on Seasoned Corporate Bonds (formerly known as
Moody's Corporate Bond
Yield Average-Monthly Average Corporates) (Moody's rate) for that month.
Who is a key person?
A key person is an officer or 20% owner. However, the number of individuals you can treat as key persons is limited
to the greater of the
Exceptions for pre-June 1997 contracts.
You can generally deduct the interest if the contract was issued before June 9, 1997, and the covered individual is
someone other than an employee,
officer, or someone financially interested in your business. If the contract was purchased before June 21, 1986, you can generally
deduct the interest
no matter who is covered by the contract.
Interest allocated to unborrowed policy cash value.
Corporations and partnerships generally cannot deduct any interest expense allocable to unborrowed cash values of
life insurance, annuity, or
endowment contracts. This rule applies to contracts issued after June 8, 1997, that cover someone other than an officer, director,
employee, or 20%
owner. For more information, see section 264(f) of the Internal Revenue Code.
Capitalization of Interest
Under the uniform capitalization rules, you generally must capitalize interest on debt equal to your expenditures to produce
real property or
certain tangible personal property. The property must be produced by you for use in your trade or business or for sale to
customers. You cannot
capitalize interest related to property that you acquire in any other manner.
Interest you paid or incurred during the production period must be capitalized if the property produced is designated property.
is any of the following.
Tangible personal property with a class life of 20 years or more.
Tangible personal property with an estimated production period of more than 2 years.
Tangible personal property with an estimated production period of more than 1 year if the estimated cost of production is
more than $1
Property you produce.
You produce property if you construct, build, install, manufacture, develop, improve, create, raise, or grow it. Treat
property produced for you
under a contract as produced by you up to the amount you pay or incur for the property.
Carrying charges include taxes you pay to carry or develop real estate or to carry, transport, or install personal
property. You can choose to
capitalize carrying charges not subject to the uniform capitalization rules if they are otherwise deductible. For more information,
see chapter 7.
Treat capitalized interest as a cost of the property produced. You recover your interest when you sell or use the
property. If the property is
inventory, recover capitalized interest through cost of goods sold. If the property is used in your trade or business, recover
through an adjustment to basis, depreciation, amortization, or other method.
Partnerships and S corporations.
The interest capitalization rules are applied first at the partnership or S corporation level. The rules are then
applied at the partners' or
shareholders' level to the extent the partnership or S corporation has insufficient debt to support the production or construction
If you are a partner or a shareholder, you may have to capitalize interest you incur during the tax year for the production
costs of the
partnership or S corporation. You may also have to capitalize interest incurred by the partnership or S corporation for your
own production costs. To
properly capitalize interest under these rules, you must be given the required information in an attachment to the Schedule
K-1 you receive from the
partnership or S corporation.
The procedures for applying the uniform capitalization rules are beyond the scope of this publication. For more information,
see sections 1.263A-8
through 1.263A-15 of the regulations and Notice 88-99. Notice 88-99 is in Cumulative Bulletin 1988-2.
If the uniform capitalization rules, discussed under Capitalization of Interest, earlier, do not apply to you, deduct interest as
Under the cash method, you can generally deduct only the interest you actually paid during the tax year. You cannot
deduct a promissory note you
gave as payment because it is a promise to pay and not an actual payment.
You generally cannot deduct any interest paid before the year it is due. Interest paid in advance can be deducted
only in the tax year in which it
If interest or a discount is subtracted from your loan proceeds, it is not a payment of interest and you cannot deduct
it when you get the loan.
For more information, see Original issue discount (OID)
under Interest You Can Deduct,
Refunds of interest.
If you pay interest and then receive a refund in the same tax year of any part of the interest, reduce your interest
deduction by the refund. If
you receive the refund in a later tax year, include the refund in your income to the extent the deduction for the interest
reduced your tax.
Under an accrual method, you can deduct only interest that has accrued during the tax year.
See Prepaid interest,
See Discounted loan,
If you contest a federal income tax deficiency, interest does not accrue until the tax year the final determination
of liability is made. If you do
not contest the deficiency, then the interest accrues in the year the tax was asserted and agreed to by you.
However, if you contest but pay the proposed tax deficiency and interest, and you do not designate the payment as
a cash bond, then the interest is
deductible in the year paid.
If you use an accrual method, you cannot deduct interest owed to a related person who uses the cash method until payment
is made and the interest
is includible in the gross income of that person. The relationship is determined as of the end of the tax year for which the
interest would otherwise
be deductible. See section 267 of the Internal Revenue Code for more information.
If you receive a below-market gift or demand loan and use the proceeds in your trade or business, you may be able to deduct
the forgone interest.
See Treatment of gift and demand loans later in this discussion.
A below-market loan is a loan on which no interest is charged or on which interest is charged at a rate below the applicable
federal rate. A gift
or demand loan that is a below-market loan generally is considered an arm's-length transaction in which you, the borrower,
are considered as having
received both the following.
The additional payment is treated as a gift, dividend, contribution to capital, payment of compensation, or other payment,
depending on the
substance of the transaction.
For any period, forgone interest
The interest that would be payable for that period if interest accrued on the loan at the applicable federal rate and was
on December 31,
Any interest actually payable on the loan for the period.
Applicable federal rates are published by the IRS each month in the Internal Revenue Bulletin. Internal Revenue Bulletins
are available on the IRS
web site at
www.irs.gov/irb. You can also contact an IRS office to
get these rates.
Loans subject to the rules.
The rules for below-market loans apply to the following.
Gift loans (below-market loans where the forgone interest is in the nature of a gift).
Compensation-related loans (below-market loans between an employer and an employee or between an independent contractor and
a person for
whom the contractor provides services).
Tax avoidance loans (below-market loans where the avoidance of federal tax is one of the main purposes of the interest arrangement).
Loans to qualified continuing care facilities under a continuing care contract (made after October 11, 1985).
Except as noted in (5) above, these rules apply to demand loans (loans payable in full at any time upon the lender's
demand) outstanding after June
6, 1984, and to term loans (loans that are not demand loans) made after that date.
Treatment of gift and demand loans.
If you receive a below-market gift loan or demand loan, you are treated as receiving an additional payment (as a gift,
dividend, etc.) equal to the
forgone interest on the loan. You are then treated as transferring this amount back to the lender as interest. These transfers
are considered to occur
annually, generally on December 31. If you use the loan proceeds in your trade or business, you can deduct the forgone interest
each year as a
business interest expense. The lender must report it as interest income.
Limit on forgone interest for gift loans of $100,000 or less.
For gift loans between individuals, forgone interest treated as transferred back to the lender is limited to the borrower's
net investment income
for the year. This limit applies if the outstanding loans between the lender and borrower total $100,000 or less. If the borrower's
income is $1,000 or less, it is treated as zero. This limit does not apply to a loan if the avoidance of any federal tax is
one of the main purposes
of the interest arrangement.
Treatment of term loans.
If you receive a below-market term loan other than a gift or demand loan, you are treated as receiving an additional
cash payment (as a dividend,
etc.) on the date the loan is made. This payment is equal to the loan amount minus the present value, at the applicable federal
rate, of all payments
due under the loan. The same amount is treated as original issue discount on the loan. See Original issue discount (OID)
Interest You Can Deduct
Exceptions for loans of $10,000 or less.
The rules for below-market loans do not apply to any day on which the total outstanding loans between the borrower
and lender is $10,000 or less.
This exception applies only to the following.
Gift loans between individuals if the loan is not directly used to buy or carry income-producing assets.
Compensation-related loans or corporation-shareholder loans if the avoidance of any federal tax is not a principal purpose
of the interest
This exception does not apply to a term loan described in (2) above that was previously subject to the below-market loan
rules. Those rules
will continue to apply even if the outstanding balance is reduced to $10,000 or less.
Exceptions for loans without significant tax effect.
The following loans are specifically exempted from the rules for below-market loans because their interest arrangements
do not have a significant
effect on the federal tax liability of the borrower or the lender.
Loans made available by lenders to the general public on the same terms and conditions that are consistent with the lender's
Loans subsidized by a federal, state, or municipal government that are made available under a program of general application
Certain employee-relocation loans.
Certain loans to or from a foreign person, unless the interest income would be effectively connected with the conduct of a
U.S. trade or
business and not exempt from U.S. tax under an income tax treaty.
Any other loan if the taxpayer can show that the interest arrangement has no significant effect on the federal tax liability
of the lender
or the borrower. Whether an interest arrangement has a significant effect on the federal tax liability of the lender or the
borrower will be
determined by all the facts and circumstances. Consider all the following factors.
Whether items of income and deduction generated by the loan offset each other.
The amount of the items.
The cost of complying with the below-market loan provisions if they were to apply.
Any reasons, other than taxes, for structuring the transaction as a below-market loan.
Exception for loans to qualified continuing care facilities.
The below-market interest rules do not apply to a loan owed by a qualified continuing care facility under a continuing
care contract if the lender
or lender's spouse is age 62 or older by the end of the calendar year.
A qualified continuing care facility is one or more facilities (excluding nursing homes) meeting the requirements listed below.
Designed to provide services under continuing care contracts (defined below).
Includes an independent living unit, and either an assisted living or nursing facility, or both.
Substantially all of the independent living unit residents are covered by continuing care contracts.
A continuing care contract is a written contract between an individual and a qualified continuing care facility that includes
all of the following
The individual or individual's spouse must be entitled to use the facility for the rest of their life or lives.
The individual or individual's spouse will be provided with housing, as appropriate for the health of the individual or individual's
independent living unit (which has additional available facilities outside the unit for the provision of meals and other personal
assisted living or nursing facility available in the continuing care facility.
The individual or individual's spouse will be provided with assisted living or nursing care available in the continuing care
required for the health of the individual or the individual's spouse.
For more information, see section 7872(h) of the Internal Revenue Code.
Sale or exchange of property.
Different rules generally apply to a loan connected with the sale or exchange of property. If the loan does not provide
adequate stated interest,
part of the principal payment may be considered interest. However, there are exceptions that may require you to apply the
below-market interest rate
rules to these loans. See Unstated Interest and Original Issue Discount (OID)
in Publication 537.
For more information on below-market loans, see section 7872 of the Internal Revenue Code and section 1.7872-5T of
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