Tax Analysis

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In the case of Wisconsin Cheeseman, Inc. v. United States, 388 F.2d420 [21 AFTR2d 383] (7th Cir. 1968), the court reasoned that the short-term indebtedness is not deductible because the purpose of the taxpayer borrowing the loan is to carry municipal bonds, and there is sufficient direct relationship between tax-exempt bonds and loan. A taxpayer borrowed the loan to meet its heavy fall seasonal financing needs, but the balance of the loan was used to purchase more municipal bonds. Moreover, during the fall in years in question, the taxpayer used its municipal bonds as collateral for a short-term bank loan. So the court decides there is sufficiently direct relationship of the continuance of the debt for the purpose of carrying the tax-exempt bonds. Like the Cheeseman case, when you take out the cash, which is already invested in CDs, and purchase more municipal bonds, the present mortgage is incurred to purchase more municipal bonds, and you can use the municipal bonds as collateral for the present mortgage. So, the interest on the present loan cannot be deducted.

You also have about $375,000 invested in state and municipal bonds, at the same time; can you deduct interest on the present mortgage loan? Norfolk Shipbuilding v. U.S, 27 AFTR 2d 71-661 (321 F. Supp. 222), (DC-VA), the court states that the direct Norfolk Shipbuilding owned various tax-exempt securities since 1953; at 1965, Norfolk Shipbuilding borrowed the loan to meet its immediate cash requirements. In that case the court decided there is no direct relationship between the loan and tax-exempt securities, and the business purpose for the loan is to meet cash requirement. The interest on the loan can be deducted. The direct relationship and business purpose is the key to determine if the interest on loan can be deducted or not.

With Wisconsin Cheeseman, Inc. v. United States, 388 F.2d420 [21 AFTR2d 383] (7th Cir. 1968), the court states that the interest on the mortgage loan can be deducted because the mortgage was for a new plant to meet a growing demand. The business purpose of borrowing the loan is to build the new plant. In your case, there is no evidence showing that the mortgage loan is incurred before or after you have those municipal bonds. But the purpose of borrowing a mortgage loan is to invest in real estate. There is no direct relationship between the municipal bonds and present mortgage. So you can hold municipal bonds while you have deducted interest on the present mortgage, which aligns with Section 163.

If my analysis has left you with any additional questions, please feel free to contact me again.

Thank you

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