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Manufacturers' Energy Efficient Appliance Credit

Tax Relief and Job Creation Act of 2010     

Act §709 – Modification and Extension of Energy Efficient Appliance Credit for Appliances Produced After 2010

In General

The Tax Relief and Job Creation Act of 2010 modifies and extends the energy efficient appliance credit for certain dishwashers, clothes washers, and refrigerators manufactured after December 31, 2010. Under Code  §45M(a)(1), the credit may be claimed as part of the Code §38 general business credit for each type of qualified energy efficient appliance produced by the taxpayer during the 2011 calendar year ending with or within the taxpayer’s taxable year.

Credit per Unit Produced Based on Energy Efficiency

The credit may be claimed on each qualifying appliance produced by the taxpayer and is based on the type of appliance, its energy efficiency, and for dishwashers and clothes washers, the amount of water it consumes. The total credit for any type of qualifying appliance is the applicable amount listed below multiplied by the eligible production for such type. §45M(a)(2). For purposes of this code section, the term “produced” includes manufactured.  §45M(f)(7).     

Dishwashers

  • $25 in the case of a dishwasher which is manufactured in calendar year 2011 and which uses no more than 307 kilowatt hours per year and 5.0 gallons per cycle (5.5 gallons per cycle for dishwashers designed for greater than 12 place settings). §45M(b)(1)(C)
  • $50 in the case of a dishwasher which is manufactured in calendar year 2011 and which uses no more than 295 kilowatt hours per year and 4.25 gallons per cycle (4.75 gallons per cycle for dishwashers designed for greater than 12 place settings). §45M(b)(1)(D)
  • $75 in the case of a dishwasher which is manufactured in calendar year 2011 and which uses no more than 280 kilowatt hours per year and 4 gallons per cycle (4.5 gallons per cycle for dishwashers designed for greater than 12 place settings). §45M(b)(1)(E)

The term “dishwasher” means a residential dishwasher subject to the energy conservation standards established by the Department of Energy.  §45M(f)(2) 

 Clothes washers

  • $175 in the case of a top-loading clothes washer manufactured in calendar year 2011 which meets or exceeds a 2.2 modified energy factor and does not exceed a 4.5 water consumption factor. §45M(b)(2)(E)
  • $225 in the case of a clothes washer manufactured in calendar year 2011—(i) which is a top-loading clothes washer and which meets or exceeds a 2.4 modified energy factor and does not exceed a 4.2 water consumption factor, or (ii) which is a front-loading clothes washer and which meets or exceeds a 2.8 modified energy factor and does not exceed a 3.5 water consumption factor. §45M(b)(2)(F)

The term “clothes washer” means a residential model clothes washer, including a commercial residential style coin operated washer.  I.R.C. §45M(f)(3).  The term “top-loading clothes washer” means a clothes washer that has the clothes container compartment access located on the top of the machine and that operates on a vertical axis.  §45M(f)(4)

Refrigerators

The credit for refrigerators is based on their energy savings relative to the energy conservation standards promulgated by the Department of Energy that took effect on July 1, 2001.  §45M(f)(8) 

  • $150 in the case of a refrigerator manufactured in calendar year 2011 which consumes at least 30% less energy than the 2001 energy conservation standards. §45M(b)(3)(E)
  • $200 in the case of a refrigerator manufactured in calendar year 2011 which consumes at least 35% less energy than the 2001 energy conservation standards. §45M(b)(3)(F)

The term “refrigerator” means a residential model automatic defrost refrigerator-freezer that has an internal volume of at least 16.5 cubic feet.  §45M(f)(5)

Eligible Production

The production in a calendar year eligible for the credit includes only the excess of the number of appliances of such type that are produced during such calendar year in the United States over the average number of appliances of such type that were produced by the taxpayer (or any predecessor) in the United States during the preceding 2-calendar year period. §45M(c) 

Limitations

The following limitations on the credit apply to taxable years beginning after December 31, 2010:

Dollar Limitation

The aggregate amount of credit allowed with respect to a taxpayer for any taxable year shall not exceed $25 million reduced by the amount of the credit allowed to the taxpayer (or any predecessor) for all prior taxable years beginning after December 31, 2010.  §45M(e)(1). The $25 million dollar limitation shall not be taken into account for refrigerators eligible for the $200 credit and clothes washers eligible for the $225 credit.  §45M(e)(2)

4% Gross Receipts Limitation

The credit with respect to a taxpayer for the taxable year shall not exceed an amount equal to 4% of the average annual gross receipts of the taxpayer for the 3 taxable years preceding the taxable year in which the credit is determined.   §45M(e)(3)

For purposes of the 4% gross receipts limitation:

  • All controlled groups of corporations, and partnerships or proprietorships that are under common control, that are treated as a single employer under §52(a) or (b) are also treated as a single producer for gross receipts limitation purposes. §45M(e)(4) & §448(c)(2)
  • If the entity was not in existence for the entire preceding 3 taxable years, the percentage of average annual gross receipts are to be applied on the basis of the period during which such entity was in existence. §45M(e)(4) & §448(c)(3)(A)
  • Gross receipts for any taxable year of less than 12 months are to be annualized by multiplying the gross receipts for the short period by 12 and dividing the result by the number of months in the short period. §45M(e)(4) & §448(c)(3)(B)
  • Gross receipts for any taxable year are to be reduced by returns and allowances made during such year.  §45M(e)(4) & §448(c)(3)(C)
  • The preceding 3 year period includes gross receipts of the taxpayer or any predecessor to the taxpayer. §45M(e)(4) & §448(c)(3)(D)

Definition of Controlled Group

Generally, controlled groups of corporations, and partnerships or proprietorships which are under common control that are treated as single employers under §52(a) or (b) are treated as single producers for purposes of the credit. §45M(g)(2)(A). Foreign corporations are not considered excluded members of a controlled group of corporations. §45M(g)(2)(B)

Verification

No amount of credit will be allowed with respect to which a taxpayer has not submitted such information or certification as the Secretary, in consultation with the Secretary of Energy, determines to be necessary.  I.R.C. §45M(g)(3) 

Carryback and Carryforward Rules

While Code §39 generally provides for a 1 year carryback and 20 year carryforward for current year business credits that exceed the limitation of Code §38(c), no portion of the unused business credit can be carried back to a tax year before the first year for which that credit is allowed. §§39(a) & (d) 

Effective Date

Act Sec. 709 applies to qualifying energy efficient appliances produced after December 31, 2010.

Page Last Reviewed or Updated: 14-Feb-2014

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H&r block free filing 4. H&r block free filing   Interest Table of Contents Introduction Topics - This chapter discusses: Useful Items - You may want to see: Allocation of InterestOrder of funds spent. H&r block free filing Payments from checking accounts. H&r block free filing Amounts paid within 30 days. H&r block free filing Optional method for determining date of reallocation. H&r block free filing Interest on a segregated account. H&r block free filing How to report. H&r block free filing Interest You Can DeductStatement. H&r block free filing Expenses paid to obtain a mortgage. H&r block free filing Prepayment penalty. H&r block free filing De minimis OID. H&r block free filing Constant-yield method. H&r block free filing Loan or mortgage ends. H&r block free filing Interest You Cannot DeductPenalties. H&r block free filing Who is a key person? Exceptions for pre-June 1997 contracts. H&r block free filing Interest allocated to unborrowed policy cash value. H&r block free filing Capitalization of Interest When To Deduct InterestPrepaid interest. H&r block free filing Discounted loan. H&r block free filing Refunds of interest. H&r block free filing Prepaid interest. H&r block free filing Discounted loan. H&r block free filing Tax deficiency. H&r block free filing Related person. H&r block free filing Below-Market LoansLimit on forgone interest for gift loans of $100,000 or less. H&r block free filing Introduction This chapter discusses the tax treatment of business interest expense. H&r block free filing Business interest expense is an amount charged for the use of money you borrowed for business activities. H&r block free filing Topics - This chapter discusses: Allocation of interest Interest you can deduct Interest you cannot deduct Capitalization of interest When to deduct interest Below-market loans Useful Items - You may want to see: Publication 537 Installment Sales 550 Investment Income and Expenses 936 Home Mortgage Interest Deduction Form (and Instructions) Sch A (Form 1040) Itemized Deductions Sch E (Form 1040) Supplemental Income and Loss Sch K-1 (Form 1065) Partner's Share of Income, Deductions, Credits, etc. H&r block free filing Sch K-1 (Form 1120S) Shareholder's Share of Income, Deductions, Credits, etc. H&r block free filing 1098 Mortgage Interest Statement 3115 Application for Change in Accounting Method 4952 Investment Interest Expense Deduction 8582 Passive Activity Loss Limitations See chapter 12 for information about getting publications and forms. H&r block free filing Allocation of Interest The rules for deducting interest vary, depending on whether the loan proceeds are used for business, personal, or investment activities. H&r block free filing If you use the proceeds of a loan for more than one type of expense, you must allocate the interest based on the use of the loan's proceeds. H&r block free filing Allocate your interest expense to the following categories. H&r block free filing Nonpassive trade or business activity interest Passive trade or business activity interest Investment interest Portfolio interest Personal interest In general, you allocate interest on a loan the same way you allocate the loan proceeds. H&r block free filing You allocate loan proceeds by tracing disbursements to specific uses. H&r block free filing The easiest way to trace disbursements to specific uses is to keep the proceeds of a particular loan separate from any other funds. H&r block free filing Secured loan. H&r block free filing   The allocation of loan proceeds and the related interest is not generally affected by the use of property that secures the loan. H&r block free filing Example. H&r block free filing You secure a loan with property used in your business. H&r block free filing You use the loan proceeds to buy an automobile for personal use. H&r block free filing You must allocate interest expense on the loan to personal use (purchase of the automobile) even though the loan is secured by business property. H&r block free filing    If the property that secures the loan is your home, you generally do not allocate the loan proceeds or the related interest. H&r block free filing The interest is usually deductible as qualified home mortgage interest, regardless of how the loan proceeds are used. H&r block free filing For more information, see Publication 936. H&r block free filing Allocation period. H&r block free filing   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 dates. H&r block free filing The date the loan is repaid. H&r block free filing The date the loan is reallocated to another use. H&r block free filing Proceeds not disbursed to borrower. H&r block free filing   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. H&r block free filing This applies whether you pay for property, services, or anything else by incurring a loan, or you take property subject to a debt. H&r block free filing Proceeds deposited in borrower's account. H&r block free filing   Treat loan proceeds deposited in an account as property held for investment. H&r block free filing It does not matter whether the account pays interest. H&r block free filing Any interest you pay on the loan is investment interest expense. H&r block free filing If you withdraw the proceeds of the loan, you must reallocate the loan based on the use of the funds. H&r block free filing Example. H&r block free filing Celina, a calendar-year taxpayer, borrows $100,000 on January 4 and immediately uses the proceeds to open a checking account. H&r block free filing No other amounts are deposited in the account during the year and no part of the loan principal is repaid during the year. H&r block free filing On April 2, Celina uses $20,000 from the checking account for a passive activity expenditure. H&r block free filing On September 4, Celina uses an additional $40,000 from the account for personal purposes. H&r block free filing 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. H&r block free filing From April 2 through September 3, Celina must treat $20,000 of the loan as used in the passive activity and $80,000 of the loan as property held for investment. H&r block free filing 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. H&r block free filing Order of funds spent. H&r block free filing   Generally, you treat loan proceeds deposited in an account as used (spent) before either of the following amounts. H&r block free filing Any unborrowed amounts held in the same account. H&r block free filing Any amounts deposited after these loan proceeds. H&r block free filing Example. H&r block free filing On January 9, Olena opened a checking account, depositing $500 of the proceeds of Loan A and $1,000 of unborrowed funds. H&r block free filing The following table shows the transactions in her account during the tax year. H&r block free filing Date Transaction January 9 $500 proceeds of Loan A and $1,000 unborrowed funds deposited January 14 $500 proceeds of Loan B  deposited February 19 $800 used for personal purposes February 27 $700 used for passive activity June 19 $1,000 proceeds of Loan C  deposited November 20 $800 used for an investment December 18 $600 used for personal purposes Olena treats the $800 used for personal purposes as made from the $500 proceeds of Loan A and $300 of the proceeds of Loan B. H&r block free filing She treats the $700 used for a passive activity as made from the remaining $200 proceeds of Loan B and $500 of unborrowed funds. H&r block free filing She treats the $800 used for an investment as made entirely from the proceeds of Loan C. H&r block free filing She treats the $600 used for personal purposes as made from the remaining $200 proceeds of Loan C and $400 of unborrowed funds. H&r block free filing For the periods during which loan proceeds are held in the account, Olena treats them as property held for investment. H&r block free filing Payments from checking accounts. H&r block free filing   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. H&r block free filing You can treat checks written on the same day as written in any order. H&r block free filing Amounts paid within 30 days. H&r block free filing   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. H&r block free filing This applies to any payment made within 30 days before or after the proceeds are received in cash or deposited in your account. H&r block free filing   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. H&r block free filing If you apply this rule to any payments, disregard those payments (and the proceeds from which they are made) when applying the rules stated under Order of funds spent. H&r block free filing   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. H&r block free filing Example. H&r block free filing Giovanni gets a loan of $1,000 on August 4 and receives the proceeds in cash. H&r block free filing Giovanni deposits $1,500 in an account on August 18 and on August 28 writes a check on the account for a passive activity expense. H&r block free filing Also, Giovanni deposits his paycheck, deposits other loan proceeds, and pays his bills during the same period. H&r block free filing Regardless of these other transactions, Giovanni can treat $1,000 of the deposit he made on August 18 as being paid on August 4 from the loan proceeds. H&r block free filing In addition, Giovanni 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. H&r block free filing Optional method for determining date of reallocation. H&r block free filing   You can use the following method to determine the date loan proceeds are reallocated to another use. H&r block free filing You can treat all payments from loan proceeds in the account during any month as taking place on the later of the following dates. H&r block free filing The first day of that month. H&r block free filing The date the loan proceeds are deposited in the account. H&r block free filing 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. H&r block free filing Interest on a segregated account. H&r block free filing   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. H&r block free filing When the interest earned is used up, any remaining payments are from loan proceeds. H&r block free filing Example. H&r block free filing You borrowed $20,000 and used the proceeds of this loan to open a new savings account. H&r block free filing When the account had earned interest of $867, you withdrew $20,000 for personal purposes. H&r block free filing 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). H&r block free filing 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. H&r block free filing 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. H&r block free filing 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. H&r block free filing Loan repayment. H&r block free filing   When you repay any part of a loan allocated to more than one use, treat it as being repaid in the following order. H&r block free filing Personal use. H&r block free filing Investments and passive activities (other than those included in (3)). H&r block free filing Passive activities in connection with a rental real estate activity in which you actively participate. H&r block free filing Former passive activities. H&r block free filing Trade or business use and expenses for certain low-income housing projects. H&r block free filing Line of credit (continuous borrowings). H&r block free filing   The following rules apply if you have a line of credit or similar arrangement. H&r block free filing Treat all borrowed funds on which interest accrues at the same fixed or variable rate as a single loan. H&r block free filing Treat borrowed funds or parts of borrowed funds on which interest accrues at different fixed or variable rates as different loans. H&r block free filing Treat these loans as repaid in the order shown on the loan agreement. H&r block free filing Loan refinancing. H&r block free filing   Allocate the replacement loan to the same uses to which the repaid loan was allocated. H&r block free filing Make the allocation only to the extent you use the proceeds of the new loan to repay any part of the original loan. H&r block free filing Debt-financed distribution. H&r block free filing   A debt-financed distribution occurs when a partnership or S corporation borrows funds and allocates those funds to distributions made to partners or shareholders. H&r block free filing The manner in which you report the interest expense associated with the distributed debt proceeds depends on your use of those proceeds. H&r block free filing How to report. H&r block free filing   If the proceeds were used in a nonpassive trade or business activity, report the interest on Schedule E (Form 1040), line 28; enter “interest expense” and the name of the partnership or S corporation in column (a) and the amount in column (h). H&r block free filing If the proceeds were used in a passive 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). H&r block free filing If the proceeds were used in an investment activity, enter the interest on Form 4952. H&r block free filing If the proceeds are used for personal purposes, the interest is generally not deductible. H&r block free filing Interest You Can Deduct 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. H&r block free filing Interest relates to your trade or business if you use the proceeds of the loan for a trade or business expense. H&r block free filing It does not matter what type of property secures the loan. H&r block free filing You can deduct interest on a debt only if you meet all the following requirements. H&r block free filing You are legally liable for that debt. H&r block free filing Both you and the lender intend that the debt be repaid. H&r block free filing You and the lender have a true debtor-creditor relationship. H&r block free filing Partial liability. H&r block free filing   If you are liable for part of a business debt, you can deduct only your share of the total interest paid or accrued. H&r block free filing Example. H&r block free filing You and your brother borrow money. H&r block free filing You are liable for 50% of the note. H&r block free filing You use your half of the loan in your business, and you make one-half of the loan payments. H&r block free filing You can deduct your half of the total interest payments as a business deduction. H&r block free filing Mortgage. H&r block free filing   Generally, mortgage interest paid or accrued on real estate you own legally or equitably is deductible. H&r block free filing 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. H&r block free filing Statement. H&r block free filing   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 1098 or a similar statement. H&r block free filing 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. H&r block free filing A governmental unit is a person for purposes of furnishing the statement. H&r block free filing   If you receive a refund of interest you overpaid in an earlier year, this amount will be reported in box 3 of Form 1098. H&r block free filing You cannot deduct this amount. H&r block free filing For information on how to report this refund, see Refunds of interest, later in this chapter. H&r block free filing Expenses paid to obtain a mortgage. H&r block free filing   Certain expenses you pay to obtain a mortgage cannot be deducted as interest. H&r block free filing These expenses, which include mortgage commissions, abstract fees, and recording fees, are capital expenses. H&r block free filing If the property mortgaged is business or income-producing property, you can amortize the costs over the life of the mortgage. H&r block free filing Prepayment penalty. H&r block free filing   If you pay off your mortgage early and pay the lender a penalty for doing this, you can deduct the penalty as interest. H&r block free filing Interest on employment tax deficiency. H&r block free filing   Interest charged on employment taxes assessed on your business is deductible. H&r block free filing Original issue discount (OID). H&r block free filing   OID is a form of interest. H&r block free filing A loan (mortgage or other debt) generally has OID when its proceeds are less than its principal amount. H&r block free filing The OID is the difference between the stated redemption price at maturity and the issue price of the loan. H&r block free filing   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. H&r block free filing 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. H&r block free filing You generally deduct OID over the term of the loan. H&r block free filing Figure the amount to deduct each year using the constant-yield method, unless the OID on the loan is de minimis. H&r block free filing De minimis OID. H&r block free filing   The OID is de minimis if it is less than one-fourth of 1% (. H&r block free filing 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). H&r block free filing   If the OID is de minimis, you can choose one of the following ways to figure the amount you can deduct each year. H&r block free filing On a constant-yield basis over the term of the loan. H&r block free filing On a straight-line basis over the term of the loan. H&r block free filing In proportion to stated interest payments. H&r block free filing In its entirety at maturity of the loan. H&r block free filing 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. H&r block free filing Example. H&r block free filing On January 1, 2013, you took out a $100,000 discounted loan and received $98,500 in proceeds. H&r block free filing The loan will mature on January 1, 2023 (a 10-year term), and the $100,000 principal is payable on that date. H&r block free filing Interest of $10,000 is payable on January 1 of each year, beginning January 1, 2014. H&r block free filing The $1,500 OID on the loan is de minimis because it is less than $2,500 ($100,000 × . H&r block free filing 0025 × 10). H&r block free filing You choose to deduct the OID on a straight-line basis over the term of the loan. H&r block free filing Beginning in 2013, you can deduct $150 each year for 10 years. H&r block free filing Constant-yield method. H&r block free filing   If the OID is not de minimis, you must use the constant-yield method to figure how much you can deduct each year. H&r block free filing You figure your deduction for the first year using the following steps. H&r block free filing Determine the issue price of the loan. H&r block free filing Generally, this equals the proceeds of the loan. H&r block free filing If you paid points on the loan (as discussed later), the issue price generally is the difference between the proceeds and the points. H&r block free filing Multiply the result in (1) by the yield to maturity. H&r block free filing Subtract any qualified stated interest payments from the result in (2). H&r block free filing This is the OID you can deduct in the first year. H&r block free filing   To figure your deduction in any subsequent year, follow the above steps, except determine the adjusted issue price in step (1). H&r block free filing To get the adjusted issue price, add to the issue price any OID previously deducted. H&r block free filing Then follow steps (2) and (3) above. H&r block free filing   The yield to maturity is generally shown in the literature you receive from your lender. H&r block free filing If you do not have this information, consult your lender or tax advisor. H&r block free filing 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. H&r block free filing Example. H&r block free filing 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. H&r block free filing The yield to maturity on your loan is 10. H&r block free filing 2467%, compounded annually. H&r block free filing For 2013, you can deduct $93 [($98,500 × . H&r block free filing 102467) − $10,000]. H&r block free filing For 2014, you can deduct $103 [($98,593 × . H&r block free filing 102467) − $10,000]. H&r block free filing Loan or mortgage ends. H&r block free filing   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. H&r block free filing A loan or mortgage may end due to a refinancing, prepayment, foreclosure, or similar event. H&r block free filing 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. H&r block free filing See Interest paid with funds borrowed from original lender under Interest You Cannot Deduct, later. H&r block free filing Points. H&r block free filing   The term “points” is used to describe certain charges paid, or treated as paid, by a borrower to obtain a loan or a mortgage. H&r block free filing These charges are also called loan origination fees, maximum loan charges, discount points, or premium charges. H&r block free filing If any of these charges (points) are solely for the use of money, they are interest. H&r block free filing   Because points are prepaid interest, you generally cannot deduct the full amount in the year paid. H&r block free filing However, you can choose to fully deduct points in the year paid if you meet certain tests. H&r block free filing For exceptions to the general rule, see Publication 936. H&r block free filing The points reduce the issue price of the loan and result in original issue discount (OID), deductible as explained in the preceding discussion. H&r block free filing Partial payments on a nontax debt. H&r block free filing   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. H&r block free filing You can deduct only the interest. H&r block free filing 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. H&r block free filing Installment purchase. H&r block free filing   If you make an installment purchase of business property, the contract between you and the seller generally provides for the payment of interest. H&r block free filing 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). H&r block free filing The amount recharacterized as interest reduces your basis in the property and increases your interest expense. H&r block free filing For more information on installment sales and unstated interest, see Publication 537. H&r block free filing Interest You Cannot Deduct Certain interest payments cannot be deducted. H&r block free filing In addition, certain other expenses that may seem to be interest but are not, cannot be deducted as interest. H&r block free filing You cannot currently deduct interest that must be capitalized, and you generally cannot deduct personal interest. H&r block free filing Interest paid with funds borrowed from original lender. H&r block free filing   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. H&r block free filing You can deduct the interest expense once you start making payments on the new loan. H&r block free filing   When you make a payment on the new loan, you first apply the payment to interest and then to the principal. H&r block free filing 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. H&r block free filing Capitalized interest. H&r block free filing   You cannot currently deduct interest you are required to capitalize under the uniform capitalization rules. H&r block free filing See Capitalization of Interest, later. H&r block free filing 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. H&r block free filing Add this interest to the basis of the property. H&r block free filing Commitment fees or standby charges. H&r block free filing   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. H&r block free filing You may be able to deduct them as business expenses. H&r block free filing   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. H&r block free filing See Capitalization of Interest, later. H&r block free filing Interest on income tax. H&r block free filing   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. H&r block free filing Treat this interest as a business deduction only in figuring a net operating loss deduction. H&r block free filing Penalties. H&r block free filing   Penalties on underpaid deficiencies and underpaid estimated tax are not interest. H&r block free filing You cannot deduct them. H&r block free filing Generally, you cannot deduct any fines or penalties. H&r block free filing Interest on loans with respect to life insurance policies. H&r block free filing   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. H&r block free filing   If the policy or contract covers a key person, you can deduct the interest on up to $50,000 of debt for that person. H&r block free filing 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. H&r block free filing Who is a key person?   A key person is an officer or 20% owner. H&r block free filing However, the number of individuals you can treat as key persons is limited to the greater of the following. H&r block free filing Five individuals. H&r block free filing The lesser of 5% of the total officers and employees of the company or 20 individuals. H&r block free filing Exceptions for pre-June 1997 contracts. H&r block free filing   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. H&r block free filing If the contract was purchased before June 21, 1986, you can generally deduct the interest no matter who is covered by the contract. H&r block free filing Interest allocated to unborrowed policy cash value. H&r block free filing   Corporations and partnerships generally cannot deduct any interest expense allocable to unborrowed cash values of life insurance, annuity, or endowment contracts. H&r block free filing This rule applies to contracts issued after June 8, 1997, that cover someone other than an officer, director, employee, or 20% owner. H&r block free filing For more information, see section 264(f) of the Internal Revenue Code. H&r block free filing 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. H&r block free filing The property must be produced by you for use in your trade or business or for sale to customers. H&r block free filing You cannot capitalize interest related to property that you acquire in any other manner. H&r block free filing Interest you paid or incurred during the production period must be capitalized if the property produced is designated property. H&r block free filing Designated property is any of the following. H&r block free filing Real property. H&r block free filing Tangible personal property with a class life of 20 years or more. H&r block free filing Tangible personal property with an estimated production period of more than 2 years. H&r block free filing Tangible personal property with an estimated production period of more than 1 year if the estimated cost of production is more than $1 million. H&r block free filing Property you produce. H&r block free filing   You produce property if you construct, build, install, manufacture, develop, improve, create, raise, or grow it. H&r block free filing Treat property produced for you under a contract as produced by you up to the amount you pay or incur for the property. H&r block free filing Carrying charges. H&r block free filing   Carrying charges include taxes you pay to carry or develop real estate or to carry, transport, or install personal property. H&r block free filing You can choose to capitalize carrying charges not subject to the uniform capitalization rules if they are otherwise deductible. H&r block free filing For more information, see chapter 7. H&r block free filing Capitalized interest. H&r block free filing   Treat capitalized interest as a cost of the property produced. H&r block free filing You recover your interest when you sell or use the property. H&r block free filing If the property is inventory, recover capitalized interest through cost of goods sold. H&r block free filing If the property is used in your trade or business, recover capitalized interest through an adjustment to basis, depreciation, amortization, or other method. H&r block free filing Partnerships and S corporations. H&r block free filing   The interest capitalization rules are applied first at the partnership or S corporation level. H&r block free filing 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 costs. H&r block free filing   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. H&r block free filing You may also have to capitalize interest incurred by the partnership or S corporation for your own production costs. H&r block free filing 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. H&r block free filing Additional information. H&r block free filing   The procedures for applying the uniform capitalization rules are beyond the scope of this publication. H&r block free filing For more information, see sections 1. H&r block free filing 263A-8 through 1. H&r block free filing 263A-15 of the regulations and Notice 88-99. H&r block free filing Notice 88-99 is in Cumulative Bulletin 1988-2. H&r block free filing When To Deduct Interest If the uniform capitalization rules, discussed under Capitalization of Interest, earlier, do not apply to you, deduct interest as follows. H&r block free filing Cash method. H&r block free filing   Under the cash method, you can generally deduct only the interest you actually paid during the tax year. H&r block free filing You cannot deduct a promissory note you gave as payment because it is a promise to pay and not an actual payment. H&r block free filing Prepaid interest. H&r block free filing   You generally cannot deduct any interest paid before the year it is due. H&r block free filing Interest paid in advance can be deducted only in the tax year in which it is due. H&r block free filing Discounted loan. H&r block free filing   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. H&r block free filing For more information, see Original issue discount (OID) under Interest You Can Deduct, earlier. H&r block free filing Refunds of interest. H&r block free filing   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. H&r block free filing 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. H&r block free filing Accrual method. H&r block free filing   Under an accrual method, you can deduct only interest that has accrued during the tax year. H&r block free filing Prepaid interest. H&r block free filing   See Prepaid interest, earlier. H&r block free filing Discounted loan. H&r block free filing   See Discounted loan, earlier. H&r block free filing Tax deficiency. H&r block free filing   If you contest a federal income tax deficiency, interest does not accrue until the tax year the final determination of liability is made. H&r block free filing If you do not contest the deficiency, then the interest accrues in the year the tax was asserted and agreed to by you. H&r block free filing   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. H&r block free filing Related person. H&r block free filing   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. H&r block free filing The relationship is determined as of the end of the tax year for which the interest would otherwise be deductible. H&r block free filing See section 267 of the Internal Revenue Code for more information. H&r block free filing Below-Market Loans 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. H&r block free filing See Treatment of gift and demand loans, later, in this discussion. H&r block free filing 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. H&r block free filing 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. H&r block free filing A loan in exchange for a note that requires the payment of interest at the applicable federal rate. H&r block free filing An additional payment in an amount equal to the forgone interest. H&r block free filing 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. H&r block free filing Forgone interest. H&r block free filing   For any period, forgone interest is The interest that would be payable for that period if interest accrued on the loan at the applicable federal rate and was payable annually on December 31, minus Any interest actually payable on the loan for the period. H&r block free filing Applicable federal rates are published by the IRS each month in the Internal Revenue Bulletin. H&r block free filing Internal Revenue Bulletins are available on the IRS web site at www. H&r block free filing irs. H&r block free filing gov/irb. H&r block free filing You can also contact an IRS office to get these rates. H&r block free filing Loans subject to the rules. H&r block free filing   The rules for below-market loans apply to the following. H&r block free filing Gift loans (below-market loans where the forgone interest is in the nature of a gift). H&r block free filing 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). H&r block free filing Corporation-shareholder loans. H&r block free filing Tax avoidance loans (below-market loans where the avoidance of federal tax is one of the main purposes of the interest arrangement). H&r block free filing Loans to qualified continuing care facilities under a continuing care contract (made after October 11, 1985). H&r block free filing   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. H&r block free filing Treatment of gift and demand loans. H&r block free filing   If you receive a below-market gift loan or demand loan, you are treated as receiving an additional payment (as a gift, dividend, etc. H&r block free filing ) equal to the forgone interest on the loan. H&r block free filing You are then treated as transferring this amount back to the lender as interest. H&r block free filing These transfers are considered to occur annually, generally on December 31. H&r block free filing If you use the loan proceeds in your trade or business, you can deduct the forgone interest each year as a business interest expense. H&r block free filing The lender must report it as interest income. H&r block free filing Limit on forgone interest for gift loans of $100,000 or less. H&r block free filing   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. H&r block free filing This limit applies if the outstanding loans between the lender and borrower total $100,000 or less. H&r block free filing If the borrower's net investment income is $1,000 or less, it is treated as zero. H&r block free filing 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. H&r block free filing Treatment of term loans. H&r block free filing   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. H&r block free filing ) on the date the loan is made. H&r block free filing This payment is equal to the loan amount minus the present value, at the applicable federal rate, of all payments due under the loan. H&r block free filing The same amount is treated as original issue discount on the loan. H&r block free filing See Original issue discount (OID) under Interest You Can Deduct, earlier. H&r block free filing Exceptions for loans of $10,000 or less. H&r block free filing   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. H&r block free filing This exception applies only to the following. H&r block free filing Gift loans between individuals if the loan is not directly used to buy or carry income-producing assets. H&r block free filing Compensation-related loans or corporation-shareholder loans if the avoidance of any federal tax is not a principal purpose of the interest arrangement. H&r block free filing This exception does not apply to a term loan described in (2) above that was previously subject to the below-market loan rules. H&r block free filing Those rules will continue to apply even if the outstanding balance is reduced to $10,000 or less. H&r block free filing Exceptions for loans without significant tax effect. H&r block free filing   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. H&r block free filing Loans made available by lenders to the general public on the same terms and conditions that are consistent with the lender's customary business practices. H&r block free filing Loans subsidized by a federal, state, or municipal government that are made available under a program of general application to the public. H&r block free filing Certain employee-relocation loans. H&r block free filing Certain loans to or from a foreign person, unless the interest income would be effectively connected with the conduct of a U. H&r block free filing S. H&r block free filing trade or business and not exempt from U. H&r block free filing S. H&r block free filing tax under an income tax treaty. H&r block free filing 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. H&r block free filing 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. H&r block free filing Consider all the following factors. H&r block free filing Whether items of income and deduction generated by the loan offset each other. H&r block free filing The amount of the items. H&r block free filing The cost of complying with the below-market loan provisions if they were to apply. H&r block free filing Any reasons, other than taxes, for structuring the transaction as a below-market loan. H&r block free filing Exception for loans to qualified continuing care facilities. H&r block free filing   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. H&r block free filing A qualified continuing care facility is one or more facilities (excluding nursing homes) meeting the requirements listed below. H&r block free filing Designed to provide services under continuing care contracts (defined below). H&r block free filing Includes an independent living unit, and either an assisted living or nursing facility, or both. H&r block free filing Substantially all of the independent living unit residents are covered by continuing care contracts. H&r block free filing A continuing care contract is a written contract between an individual and a qualified continuing care facility that includes all of the following conditions. H&r block free filing The individual or individual's spouse must be entitled to use the facility for the rest of their life or lives. H&r block free filing The individual or individual's spouse will be provided with housing, as appropriate for the health of the individual or individual's spouse in an: independent living unit (which has additional available facilities outside the unit for the provision of meals and other personal care), and assisted living or nursing facility available in the continuing care facility. H&r block free filing The individual or individual's spouse will be provided with assisted living or nursing care available in the continuing care facility, as required for the health of the individual or the individual's spouse. H&r block free filing For more information, see section 7872(h) of the Internal Revenue Code. H&r block free filing Sale or exchange of property. H&r block free filing   Different rules generally apply to a loan connected with the sale or exchange of property. H&r block free filing If the loan does not provide adequate stated interest, part of the principal payment may be considered interest. H&r block free filing However, there are exceptions that may require you to apply the below-market interest rate rules to these loans. H&r block free filing See Unstated Interest and Original Issue Discount (OID) in Publication 537. H&r block free filing More information. H&r block free filing   For more information on below-market loans, see section 7872 of the Internal Revenue Code and section 1. H&r block free filing 7872-5 of the regulations. H&r block free filing Prev  Up  Next   Home   More Online Publications