Q: If a corporation owes money to a shareholder but does not actually pay the interest for the year, can the corporation still deduct the interest? I own all of the stock in this corporation and I loaned it $120,000 last year. The loan calls for 4.5 percent interest but no payments (principal or interest) have been made. The reason I ask is the corporation uses accrual accounting and it seems like I should be able to take a deduction for four months of accrued interest for the time the loan was outstanding in 2012. This loan will be repaid, but the corporation has a lot of startup costs and is short of cash right now.
A: As a general rule, it is possible for an accrual method taxpayer to claim a tax deduction for interest as it accrues (which occurs as time passes). However, there is an exception when the interest is owed to a related party.
With related-party transactions, including loans, the party that would be entitled to a deduction cannot claim that deduction until the related party on the other side of the transaction reports income.
As an individual, you would report using the cash method of accounting, which means you have no income until you actually receive a payment of interest.
Because the loan is between related parties, the corporation cannot claim a deduction until you report the income, which occurs only as interest payments are actually made.
There is one exception that applies when the loan is made without “fair” interest being charged. In such cases, interest is deemed paid by the borrower and received by the lender at a rate set monthly by the IRS.
Your loan calls for fair interest. However, if you get too far down the line with no payments made, it is possible that the substance of the loan could be a below market loan (interest is called for, but not paid, which is, in substance, the same as a zero interest loan).
Q: I own a commercial building that has been vacant for the past six months. About four months ago I started to let a new church use the facility for Sunday services. They use it two nights a week for Bible studies and administrative meetings. My question is whether I can claim a charitable deduction for the fair rent that would be charged for the use, and how can I document this for the IRS?
A: No charitable deduction is allowed for donations of partial interest in property (except for conservation easements). For example, loaning a painting to a museum leads to no deduction because the transfer is limited to a specified time.
Similarly, donating the use of a building to a qualified charity is treated as the transfer of a partial interest in the building. So no tax deduction is allowed.
If you have direct out-of-pocket costs associated with the charity’s use, you could deduct those costs.
Q: I am selling a rental house in Santa Fe and I want to do a Section 1031 like-kind exchange to avoid paying taxes. I think that I will be buying a replacement rental in Carlsbad, Calif. I know I can avoid federal taxes, but I need to know if New Mexico requires that the replacement property be located in New Mexico to avoid paying state tax.
A: There is no requirement that the replacement property be located in New Mexico to receive the same deferral of taxes for sale of the Santa Fe property. Your sale can be nontaxable for both federal and state even with California replacement property.
Because the replacement property is real property, you will shift the deferred gain from the sale of the Santa Fe property from New Mexico to California.
A later taxable sale of the California property will be taxed only in California, at a higher rate than New Mexico imposes, although some of the gain was deferred from the Santa Fe property.
The ability to shift the gain to another taxing jurisdiction has caused some states to require that replacement property be located in the same state as the property sold. But New Mexico, like most states, does not have this requirement.
James R. Hamill is the director of Tax Practice at Reynolds, Hix & Co. in Albuquerque. He can be reached at email@example.com.