3 Properties In 1 Loan: How Do I Report Interest?

I was given a single loan for 3 different properties as collateral. So, how do I report interest when I file my taxes?

Do I pro-rate each property and report the pro-rated interest amount for each property? Or do I simply report all 3 properties as if they were one?

Thanks in advance everyone! -Tony

Use your imagination. Does anyone other than you know the specifics?

Personally, I would pro-rate expenses. Then, if you sell one, the cost and expense basis is already established for the remaining properties.
[addsig]

In my mine the dingle note is earning the income.. The fact that it's cross-collat buy 3 properties is a side issue.

What did you do with the loan proceeds? It is not clear from your question whether you did a cash out refinance with three properties as collateral, or got a blanket mortgage to purchase three properties.

How you deduct the loan interest depends upon what you did with the money.

Thanks for the replies guys.

Newkid: It was a refi. I had seperate mortgages on all 3 properties but interest rates went down, so I got a business loan to cover all 3 properties (12-unit, 3-unit, & townhouse) at 6.1% (5 year term).

Bargain: I'd LOVE to keep everything seperate because I may sell just one in the future, but that's why I'm here, to see if anyone knows whether the IRS will even let me do that or not.

cjmazur: I don't understand your comment; sorry.

When the lender sends the IRS the form stating the interest I paid on the loan (form 1098 - interest), it'll be one sum, not 3 seperate. Will the IRS let me divide that sum up into 3 amounts I associate with each property? I have been keeping these properties seperate and would like to continue.

-Tony

[ Edited by tony17112acst on Date 11/21/2008 ]

Abviously, "discuss this matter with your accountant." A few years ago, we needed to determine the basis on a property which had been divided into a number of parcels/lots. I discussed it with my accountant at the time, and there appeared to be a bit of flexibility. Methods we considered were: number of living units, square footage of buildings, and square footage of lots upon which the buildings were located. It appeared various methods would be acceptable as long as there was a reasonable rationale for the allocation,

If I may clarify for cjmazur, a "dingle" note is the fast typer, no editing way of saying "single" note. A common problem in his posts.

My interpretation is that all of the income is balanced by all of the payments on the single note- in other words, he treats the properties as a group rather than individually.

Tony,

Like MAT3 mentioned above, as long as you use a reasonable method that you can explain to seperate the interest, you should be fine. If I were you, I would use as a basis the relative value of each property at the time the loan was acquired. Obviously, the amount of the loan was based on a valuation of each property to come up with the total. Use that as a basis to calculate your percentage for each property and you should be okay.

My limited expertience with accountants and the IRS has taught me that the thing they love the best is consistency. Say you tried to change the percentages after 3 years, then I believe you would have a problem. But as long as you establish each percentage and maintain those same perecentages as long as you own the properties, you should be fine. At the end of the day, the amount of interest you are deducting would not be any greater or any less by splitting it up consistently amonthst the three properties.

Disclaimer: I am not a Tax Expert and this is just what I would do if I were in your position.

As a side question, how did you get a business loan to cover multiple properties? I am looking at doing the same thing for several SFR's that I own.

Would you mind sharing some pointers on how to get this "business loan" or "blanket mortgage"? Which Bank did you use and how did you establish the busniess relationship? Did you need to personally co-sign the loans, i.e. was your personal credit history considered for this loan and does it show up on your personal credit report?

Thanks.
JS.

Guys,

You are all shooting in the datk. Until Tony answers the basic questions I asked about his loan, you can't give an informed response.

Telling Tony to get creative, to use "reasonable" property values, or to allocate based on property expenses is way off base. You only need to know the amount of debt for each property that was refinanced, and what he did with any amount he "cashed out."


Tony,

Even though you did not give us any numbers or specific details, here is how the IRS will have you approach the problem.

Let's say you had three rental properties (A, B, and C) with mortgage balances of $20K, $30K , and $40K, respectively, Let's say you got a blanket mortgage for $100K which gave you $10K cash out which you used to buy a new fuel efficient car. At the end of the year you get a 1098 from the lender telling you that you paid $6000 in mortgage interest on your blanket loan during the year.

Your question is how you claim the mortgage interest.

You claim the mortgage interest deduction against the asset for which the loan proceeds were used. $20K of your $100K loan refinanced property A, so 20% of your mortgage interest is deducted on the Schedule E for property A. 30% is deducted on Schedule E for property B, and 40% is deducted on Schedule E for property C. The last 10% is not deducted at all because the loan proceeds were used for non-deductible personal expense.

If the last 10% was used to improve your personal residence, then the last 10% of the mortgage interest is deducted on your Schedule A as home mortgage interest -- but only if you tiemize your deductons. If you don't itemize, you lose the mortage interest deduction.

If you used the money as a down payment for another rental property, then the 10% is deducted as mortgage interest on the Schedule E for the new property.

Relative value and total expenses for each property are irrelevant to the question. Getting creative could get you in trouble with the IRS,

Thanks everyone.

It sounds like that pro-rating the interest expense on the 1098 form is acceptable to the IRS (which is what I wanted to do if it were allowed).

I didn't give specifics on my situation so I could get general answers which can be applied to any situation.

There was no cash-out, so it sounds like I just need do assign a percentage of debt to each property.

Thanks again folks! I was thinking of calling the IRS but the last time I called them, they told me something TOTALLY false. I'm sure I'd pay fees/fines for doing what they instructed me to do if I had actually followed their advice.

-Tony

thank ypochris.. My fingers don't move fast enough.

Tony: The point I was trying to make is that is there is a single promissory note, and a trust deed which name 3 different properties as collateral, that to me is a single loan/note. If there are 3 notes, and a property per note, that would be 3 notes.

Seeing that it seems that it's a single note, why would 3-1098s be required? What pro ration is required?

People: keep track of the advise you get from the IRS. As I understand, If you use their advise, the IRS can correct the tax amount due, but the IRS can't penalize you for using the advise.

Smithj2: I forgot to answer your questions. I got the blanket mortgage by using my local federal credit union. I was unaware that it is difficult to get a blanket loan, so I really do not have any advice relating to it.

I know they required my loan to have a $750,000 balance to do the deal. My loan officer called it a blanket mortgage but the documents I get in the mail call it a business loan.

I did apply to a bank as well and they denied me saying that my debt to income ratio was too high. Members 1st Fed. Credit Union approved me with the exact same credentials.

I originally call Members 1st becasue the fellow I purchased my 12-unit from recommended them. I really didn't have to establish a relationship, but things have gone so well (financially) that they are now eager to lend me money/make deals.

Also, yes, this deal was done based on my persoanl finances and shows up on my personal credit report. So maybe technically it isn't a business loan.

-Tony

cjmazur: Just to clear things up:

I KNOW I'm getting one 1098 form for the loan. I am simply asking: SINCE I'm getting a single 1098 form, am I required to pool all 3 properties into one column on my Sched E ...or can I still use 3 seperate columns for each property and divide up the interest on the 1098 into 3 pro-rated amounts.

I again thank everyone for helping answer my question; I am amaized how fast you all replied; THANKS AGAIN!

-Tony

That sounds like a purely account issue.

There may be some benefit to "charge back" a different ration to a specific property. A reason that comes to mind is 1 prop is a MF that is cash flowing and the 2 other are vacant lots.

In this case it would see you'd want to wipe ope as much of the income as possible.

I would say this is something a more experienced account/atty would advise you on.

cj,

The rules for Allocation of Interest are specifically detailed in IRS Pub 535.

I am sure that a more experienced account/atty would advise that making up your own rule which does not conform to IRS Pub 535 will not survive an audit.

MAT3Sigma,

You are giving bad advice. The IRS rules for deducting interest expense are specific. There is no room for flexibility to make up your own rule.

Mortgage interest follows the loan proceeds. If the loan proceeds from a refinance on property A are used to purchase property B, then the mortgage interest deduction is taken in the manner allowed for deductions for property B

If the loan proceeds are not spent at all, but rather put ni the bank for use at a later time, then the mortgage interest is not deductible at all since the loan proceeds were applied to a personal use .

Makes no difference that the loan is secured by property A.. The value of property A is irrelevant, and the income generated by property A is immaterial.

NewKidInTown3: I think MAT3Sigma is referring to MY specific example. I have one blanket loan three properties A, B, AND C and my question is, do I put all 3 properties in one column on my Shedule E, or do I seperate them into 3 seperate columns. She's saying that I can do either.

I dont think she's suggesting that you can get a loan on a single property and start applying the interest deduction to some other unrelated property.

Maybe I'm misunderstaing your post too, please let me know.

-Tony

You have three properties. Each property had debt. You refinanced that debt. The amount of the debt you refinanced for each individual property, is still acquisition debt for that property.

The portion of your mortgage interest that applies to that property's original loan amount is still expensed on the Schedule E for that property.

Let's say you have three rental properties -- A, B, and C -- with loan amounts of $27K, $33K, and $40K. You decide to refinance all these loans into one $100K blanket mortgage with all three properties as collateral for the loan. At the end of the year, you get a 1098 saying that you paid $6000 in mortgage interest during the year.

You allocate the mortgage interest to each property in proportion to the amount of the loan that was refinanced for each property. 27% of your new loan refinanced Property A, 33% of your new loan refinanced property B, and 40% of your new loan refinanced property C.

Your mortgage interest deduction on the Schedule E for property A will be 27% of $6000, or $1620. The Schedule E deduction for property B will be $1980. The Schedule E deduction for property C will be $2400.

This does not apply in your case, but I am also saying that the mortgage interest is deducted against the asset the loan proceeds purchased, not necessarily against the asset that secures the loan.

For example, you use the equity in your primary residence to take out an equity loan for $75K which you then use to purchase a rental property. You gave a mortgage on your primary residence to secure the equity loan. The rental property is owned free and clear.

Now, at the end of the year, you get a mortgage interest statement from your lender for the home equity loan. The mortgage interest deduction for your equity loan is taken on the Schedule E for the property you bought, and NOT taken as a home mortgage interest deduction on Schedule A.

Does this clear it up?

Since all the Schedule E entries are all added up together and reported as a single income or loss entry on page 1 of your 1040, it would not seem to make any difference in your tax bill if all three properties are lumped together in a single entry on your Schedule E.

In practice, however, you have three rental activities with separate income, separate expenses, and separate depreciation schedules. The IRS wants you to account for all the rental income and expenses for each activity.

If you have suspended passive losses, the IRS wants you to separately track the amount of suspended loss for each property, too.

When you sell just one of the properties, you will need to calcuate your adjusted cost basis for that property and the amount of unrecaptured depreciation for that property, which will be a lot easier to defend to the IRS auditor if you maintain a separate Schedule E entry for each property.

It is a lot easier to maintain continuity with your prior year's tax returns too. Changing your tax reporting to lump everything together into a single Schedule E may raise an audit flag. The IRS will want to know what happened to the three properties you had last year that you are not reporting this year and not reporting a sale.

You have three separate rental activities, so report them in three separate columns on your Schedule E..


[ Edited by NewKidInTown3 on Date 12/06/2008 ]