Business expenses need to be ordinary and necessary to be deductible and a mortgage interest falls under that category.Originally posted by "hjorgan":Can anyone think of a way to achieve these objectives without selling property A?

Its really just an ordinary transaction.

Then, she will pay tax on the money when she does take it out.If she takes it out now, paying the taxes, then she will still have to pay ordinary taxes on the gains, but these are at lower rate than the UBIT.

If you take the distribution, you are going to pay ordinary income taxes on it plus a 10% penalty so it would really depend on when you did this as that could amount to a significant chunk of money out of your account.

Anish,The IRS divides up income into three buckets: ordinary, passive, portfolio.Your W-2 income is considered ordinary.Your rental loss is considered passive loss.Any interest, dividends, or capital gains are considered portfolio. 

It is subject to ordinary income tax.  

Is there any way to structure a note such that the "interest" it is not taxed at ordinary income rates.

The difference will be taxed at the current depreciation recapture rate and the remainder at whatever rate you fall into whether capital or ordinary, fed and state, and tax bracket sensitive.  

Add to that your large annual ordinary income and it's a recipe for a big tax bite.So, before you discard the 1031 idea because there is no capital gain you need to do a two part exercise.1.

So even if you are exempt from CG tax because you do not go above the 2nd tax bracket, dep.recapture is always considered ordinary income.