J.K. Lasser's Small Business Taxes 2013: Your Complete Guide to a Better Bottom Line

Nondeductible Interest and Other Limitations on Deductibility

If you borrow additional funds from the same lender to pay off a first loan for business, you cannot claim an interest deduction. Once you begin paying off the new loan, you can deduct interest on both the old and new loans. Payments are treated as being applied to the old loan first and then to the new loan. All interest payments are then deductible.

As in the case of taxes, if interest is paid to acquire a capital asset for resale, you must capitalize the interest expense. The interest is recovered when the asset is sold.

Commitment Fees

Fees paid to have business funds available for drawing on a standby basis are not treated as deductible interest payments. They may, however, be deductible as business expenses. Fees paid to obtain a loan may be treated as deductible interest. However, the fees are not immediately deductible; rather, they are deductible only over the term of the loan. If the loan falls through, the fees can be deducted as a loss.

Similarly, points paid to acquire a loan on business property are treated as prepaid interest. They are not currently deductible as such. Instead, they are deductible over the term of the loan.

Example

Your business pays a $200 commitment fee for a $10,000 loan with a 10-year term. Each year the business may deduct $20 ($200 divided by 10 years).

If you pay off the loan before the end of the term (before you have fully deducted the prepaid interest), you can deduct ...