Interest Deduction Determined Based on Use of Loan Proceeds – Ellington v. Commissioner
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Interest Deduction Determined Based on Use of Loan Proceeds – Ellington v. Commissioner

Business Entity Selection and the Tax Consequences of Converting

Interest Deduction Determined Based on Use of Loan Proceeds – Ellington v. Commissioner

If you incur interest expense on loans you should use the tracing rules of Reg. §1.163-8T to determine whether the interest expense is for:

1. business

2. investment

3. passive activities. or is

4. personal in nature

The regulation focuses on the use of the loan proceeds, not the item or items used as collateral for the loan.

Reg. §1.163-8T(c)(1) even sets forth an example of a taxpayer pledging his corporate stock as security for a car loan. In the example, the conclusion is that the loan interest is personal based on its use to purchase a personal use vehicle. In order to properly deduct the interest, it is essential to determine and document the use of the loan proceeds received as evidenced in James Ellington, et ux. v. Commissioner TC Memo 2011-193.



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