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Question: At age 52, I sold a business that I had run for the previous 17 years. I received enough money to retire, and it seemed like a great opportunity to pursue other interests. Now, eight years later, I am increasingly bored and would like to get back into running a business. Two years ago, my wife and I bought a new house for $950,000 and paid cash. We now want to start a franchise business and need $550,000 to get started. I want to borrow against the house because that seems like the least amount of paperwork and the interest rate is as good as I can get for any other type of loan. I have been told that if the loan is secured by the house, it is called residence debt. This allows an itemized tax deduction. I would rather deduct the interest as business debt, and I am told there is a special election to allow me to do this. Can you confirm this and explain how I make the election?

Interest expense is classified in categories, some of which are deductible, some not, and some that are deductible in a more favorable way than others.

Personal interest is generally not deductible with the recently added exception of qualified vehicle loans.

Business interest is deductible without limit for a business like yours (larger businesses may be subject to a limit).

Business interest is the most favorable category because it offsets the business income, whether or not you itemize deductions.

Residence interest is deductible as an itemized deduction. Residence interest is for a loan to acquire, construct or improve a residence (with a limit of two).

The interest deduction for residence interest is limited to the amount on $750,000 of principal ($1 million for older loans).

Normally, classifying interest among the categories is done by 鈥渢racing.鈥� That is, you follow the loan proceeds to a use to determine the classification.

The exception is residence interest. If the loan is secured by a qualified residence, the interest is deductible. This avoids tracing to what is otherwise a personal use.

There is an election that allows someone to bypass the automatic residence classification and instead trace the loan proceeds to determine the classification.

You do not need to make this election. This is because you do not have residence interest even if the new loan is secured by your home.

The loan proceeds will not be used to acquire, construct or improve your residence. Therefore, the interest cannot be residence interest.

This allows you to use the normal tracing rules to determine the status of the loan. If you use the proceeds of the loan for a business, the interest is business interest.

There are some other rules that might apply to you. If the proceeds are placed in an investment account pending purchase of the franchise, the interest is investment interest.

This investment classification continues only until you use the proceeds to purchase the franchise. Thereafter, the interest becomes business.

If you use the loan proceeds to purchase the franchise within 30 days of deposit, you may treat the interest as business from the first day.

Question: I will have to pay a 鈥渟pecial assessment鈥� tax of $8,200. Is this a deductible property tax?

That is hard to say. It depends on what the assessment will be used for. It sounds like it will benefit a limited number of properties.

A property tax is deductible if it is imposed on real property and is imposed to fund general public benefits.

Something may be called a special assessment and still be a deductible property tax if it provides funds for the benefit of the general public.

The name given to the assessment is not important. It is the use of the funds that determines the tax result.

An assessment that is used to fund local improvements to a limited number of parcels subject to the assessment is not a deductible tax.

A local benefit assessment is levied against designated parcels and is determined by the benefit expected to accrue to those parcels.

Local benefit assessments are not deductible property taxes, but they will add to the tax basis of the property and may reduce a gain from a future sale of the property.

Jim Hamill is the director of tax practice at Reynolds, Hix & Co. in sa国际传媒官网网页入口. He can be reached at jimhamill@rhcocpa.com.