Deducting interest on a commercial loan?

[Roger Gelpey]

I have had contradicting advice regarding a loan we are contemplating so please help me!! We are considering taking out a commercial loan on a rental property we own in our own names and to use the funds for other RE investments in multiple states. The property is free and clear now. We have been told by a national legal/tax firm that we can create an LLC to hold the investments and that LLC would be a pass through entity so that the income and deductions will flow to our personal returns. According to them if we loan funds to the LLC with a promissory note at the same interest we are paying on the loan....

1) The LLC will claim a deduction on the interest paid to us personally. Then the deduction will flow to our return.

2) We will report as interest income the interest paid by the LLC on our personal return.

3) We will report as investment interest expense the interest paid to the bank that issued the commercial loan.

A second scenario outlined (and more streamlined) is to transfer ownership of the property directly to the LLC and have the LLC borrow the money, that way the income and deductions flow to our personal returns.

I have had some trouble following the logic of these scenarios and a local CPA has told my wife that it isn't legal to deduct interest on any money borrowed in this way under any scenario. I would greatly appreciate opinions from more experienced pros here!

Thank you

[Michael Plaks]

@Roger Gelpey

The 1st scenario may be a problem under the new tax law, depending on how much personal itemized deductions you have. If they do not exceed $24k - then the 1st scenario will hurt you.

The 2nd scenario is good for taxes but may get nixed by your lender if they do not want to lend to the LLC - or make the terms of the loan worse because of the LLC.

There's a 3rd scenario, simpler than the two you listed. Create an LLC for asset protection but treat it as a disregarded entity for taxes - i.e. report it on your personal tax return, just like you already do with the existing property. Then the interest is simply deducted on your personal Sch E against the new properties.