Q:

Subject: Investment Interest

 

Dear Mr. Kerstetter,

 

I have client who set up a family limited partnership with his children. The Partnership invests primarily in vacant land, has some debt which generates

investment interest expense.

Occasionally, the Partnership sells some of the land at fairly large capital gains; however, there are not sales in every year so that in some years there is little or no income.

My question is: is it more advantageous to expense the investment interest as incurred and defer it to years when there are gains or to capitalize the interest to the cost of the underlying properties? For example, in 2004 each of the children has approximately $58,000 of capital gain income.

The children do not have any income or deductions other than that generated by the Partnership.

A:

As you obviously know, there is no universally best answer for this kind of thing. 

However, there are some key factors that you may want to consider.

Even if you enter the investment interest on the tax return each year, what will actually be deducted may be a small part of it, or even none at all, since the actual deduction is limited to the investment income reported on that year’s 1040. Nondeductible interest carries over to future years where it can be claimed when there is sufficient investment income.

Another issue to consider is the different tax rates.  Capitalizing the interest would reduce the long term capital gain (LTCG), which is taxed at the lowest rates available (5% or 15%).  A deduction for investment interest could conceivably reduce the taxes by the normal marginal rate of up to 35%.

Based on just those points, it would most likely be advantageous to forgo capitalizing the interest (increasing LTCG) and entering the interest each year as potentially deductible investment interest.

There may be other factors peculiar to your situation that would warrant a different approach.

Good luck.  I hope this helps.

Kerry Kerstetter

 

From a Texas CPA:

Subject: thank you for blogging

 

just want to say thank you for blogging.

 

as a sole practitioner, i have a few cpa friends with whom to reflect.  still, this is the 2nd time

that i’ve taken the privilege of using your [written] blog responses to prove a tax point.

i know this uses time, and your time has a serious value, so it’s only proper to say thank you.

 

sincerely,

My Reply:

I’m glad to see that you have been finding my postings useful.  Feedback such as yours is very nice to receive.

Please feel free to pass along any issues you would like to see discussed, including a “guest column” if there is something that you would like to say that I may not have covered as completely as may be needed.

I would also be glad to pass along any tips on producing a blog in case you would like to give it a try on your own.  I have learned a lot though trial and error and continue to learn new things every day about this extremely effective medium.  For any practitioner building a practice, a blog seems to be a very effective way to put yourself out there.  It is definitely less time consuming than  than the ways I used to build up my firms here in Arkansas an back in the Bay Area, traveling all around giving speeches and seminars. 

Blogging does take a bit of time; but is still much faster than podcasting, which is the next medium I am looking into.

Good luck.

Kerry Kerstetter

 

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