Your banker has just informed you that the loan for your business has been approved. You’ve spent hours pulling together information for the application and you’ve incurred some expenses along the way. What costs can you deduct and when can you deduct them?
There are various costs associated with getting a business loan. Some are directly related, others indirectly. Direct costs of a loan include title work, such as Uniform Commercial Code filing fees or deeds of trust, and lien searches.
Here are some indirect costs. If you’re the business owner and you’re critical to repayment of the loan, the bank may require you to take out a “key-person” life insurance policy, with the bank as beneficiary. If your loan collateral is real estate, the bank may need to verify that your property taxes are paid up. Also, proof of adequate property insurance is usually needed.
Many types of loans require you to provide a certificate of insurance with the bank named as a beneficiary. If you don’t have adequate insurance the bank may get it for you and then include the cost in your monthly payments. (If the bank does it for you, it usually costs more.)
Other indirect costs related to a loan include accounting fees to prepare the necessary financial documents, such as compiled or reviewed financial statements and personal financial statements. Indirect costs can also include attorney’s fees for reviewing the documents prepared by the bank.
What Costs Can You Deduct? And When?
Annual interest expenses incurred and paid over the life of your loan can be used to reduce taxable income. Other deductible expenses include accounting fees, business insurance premiums, and any real estate taxes paid at the time of loan closing. These expenses are generally deducted on an annual basis.
Any fees paid to an attorney to review the documents are normally deductible at the time you pay them. In some cases attorney fees may have to be capitalized and added to the cost of the property, then amortized over the life of the loan.
The title work and any points paid are capitalized and written off “ratably” over the life of the loan. Let’s say you paid $1,000 for title work, filing fees, and points on a $50,000 three-year loan. Each month you would write off $27.78 of these costs ($1,000 over 36 months). If the loan is paid off early, either by refinancing or accelerated payments, then the remaining capitalized costs are written off in full at the time of refinancing.
Financing operations or capital expenditures by borrowing money from banks or other lenders usually helps your cash flow. It’s important to identify and appropriately categorize the costs associated with a loan for both accounting and tax purposes. Being an informed bank customer will help your business.
Pam Feely is the president of Feely & Associates in Lakewood, Colorado.