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