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Loan Interest Capitalized

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#1
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Client is cash basis. They have a bank loan with interest accrued. Bank agrees to add accrued interest to the loan principal (capitalizes the interest). Client desires to show the correct loan principle balance in QuickBooks. No interest paid on the loan re-write. Client credits Loans Payable for the interest amount capitalized. Client debits (your answer here:______________)
Again, no interest paid, no cash changes hands, cash basis QB. My thinking is a contra Equity account of some nature, as the client's Liabilities have increased, and no Asset added or cash expenditure. I also sometimes think I'm a genius. Which will now be proven incorrect. Don't tell my wife. (Edited to correct "principle' to 'principal', as a matter of principle.)
 

#2
sjrcpa  
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Interest expense.
Nondedeductible for tax purposes.
 

#3
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Thank you. That makes sense, since the interest portion of future payments would be based on the revised principal balance.
At the end of the accounting period, the expense would close out to equity. Debits equal credits. Life is good.
 

#4
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I can’t say I agree with SJR here.

Assume these are the facts: $100k loan principal. $10k of accrued interest that will be added to loan principal.

SJR would have us debit ND interest expense for $10k, debit off the old loan for $100k, and credit the new loan for $110k. Then he’d have us run a single Am Sch on the $110k new loan.

If we go that route, we never get a deduction for any part of the $110k new loan “principal.” This doesn’t make much sense to me. We should be able to deduct $10k (accrued interest component) of that $110k.

People sued BOA over this, you know:

https://procedurallytaxing.com/bank-of- ... -payments/
 

#5
Nilodop  
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Seems this is (at least mainly) a tax question, though of course it involves accounting. If Admin agrees, maybe it can be moved.

I'd say Jeff-Ohio is on to something pretty important here. By doing what sjrcpa and klotzbach suggest, there'd be a permanent loss of the (hypothetical) $10k interest deduction. Sure, they'd get a 1098 from the lender, but it, too, would probably be wrong, in that it would only have the interest on the $110k new loan. That's what BOA's issue was.

The accounting (and tax) entry (assuming it's correct that no deduction for interest was allowed in the years of accrual but no payment) would be more like a debit to something called "interest accrued but not paid" or a similar title. [It's OK to use lower case type]. Then that debit balance sheet account would be amortized each year to interest paid (and therefore deductible) as payments are made on the new loan, said payments now including principal and interest on the new loan and part of the interest that was added to the new loan. Debits would still equal credits, and life would be even better.

Now back to why I wrote this:(assuming it's correct that no deduction for interest was allowed in the years of accrual but no payment). I wrote it because it's unclear to me whether OID was considered (and whether it would apply, because we don't have sufficient facts). That should be seriously reviewed.
 

#6
Nilodop  
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I agree w/Jeff-Ohio. I hope OP comes back and sees this so he can correct his thinking and properly advise his clients. They will love him.

Unless, of course, the bank has corrected its 1098 procedures. (A surer way is to keep track via the client's records.)

https://www.markhamandcompany.com/wp-co ... rticle.pdf

http://procedurallytaxing.com/wp-conten ... missal.pdf

https://www.courtlistener.com/docket/59 ... merica-na/
 

#7
Nilodop  
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Or maybe I (and possibly Jeff-O) have erroneously assumed this loan was a mortgage for which the bank would produce a 1098 after year-end. So now let's assume it's just a common commercial loan such as those used for operating a farm or a business. Based on posts #2 and 3, OP and sjrcpa will debit the accrued interest (that was added to principal) to non-deductible interest expense, which closes out to equity. Now debits equal credits and the balance sheet is stated correctly. And the interest, not having been paid, is in fact not deductible.

When and how does the client get the deduction for the interest that he ends up paying as part of the new principal?

You see, this accounting question becomes also a tax question.
 

#8
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Has Klotzbach come back yet?

He was wondering about that debit. He was kind of, but not entirely, on the right track with his contra equity comment. It should be booked as a debit to the Balance Sheet, as Nilodop says in post #5. And then it should be amortized down to Interest Expense. Hopefully Klotzbach will see this post and all the other ones. Otherwise, he’ll be missing a legitimate deduction for his client. Could even be malpractice.
 

#9
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NC
Deferred interest, credited as the interest becomes deductible.
 


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