IRS allows no interest deduction when borrowing from a 401 (k)


Q. I borrowed $10,000 from my 401(k) plan at work to buy a house and will repay the loan plus interest over a five-year period. Can I deduct the interest on my income tax?

A. There is a lot of confusion regarding what constitutes a tax-free loan as opposed to a taxable distribution from a 401(k) plan. There are strict rules on the amount of money borrowed and the repayment schedule. One key ingredient in determining if it is really a loan is repaying the amount withdrawn in substantially level payments at least quarterly. But even when you meet all the requirements for a 401(k) loan, the IRS has ruled that you may not deduct the interest on a loan that is secured by amounts attributable to elective deferrals, such as 401(k) plans.

Q. Because the real estate market is so weak nowadays, my husband and I are having a very difficult time trying to sell our home. It's been on the market for ten months and we have not received a good offer. If we rent out our home while we try to sell, does that change our ability to count the home as a primary residence and defer taxes on any gain?

A. Many people are in the same boat as you are and are renting out their homes while they wait for a buyer to come along. The Tax Court has ruled that people can temporarily rent out their homes and not lose the primary residence status or tax deferral on the gain when the house is sold as long as the rental was necessitated by factors in the real estate market or was part of a sales approach (such as rent with an option to buy).

Q. I loaned $5000 to a cousin in 1989 to help him start up a new business. He was supposed to pay back half of it in 1990 and half in 1991. However, because of the weak economy he was not able to pay any of the money due last year and agreed to pay all of it this year if business picked up.

Based on our original agreement, which I have in writing, can I claim $2500 as a bad debt on my 1990 tax return?

A. Getting a deduction for a bad debt is a tricky business. The IRS is strict about meeting certain guidelines. Since you have a written agreement indicating the terms of the loan and the due date for repayment, you are well ahead of he game. You don't indicate, however, if any interest was charged on the loan, which is something the IRS looks for.

Send questions to Karen Lazarovic, Columbia Features Inc., PO Box 1957, New Smyrna Beach, Fla. 32170.

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