4.14 Interest Income on Debts Owed to You

You report interest earned on money that you loan to another person. If you are on the cash basis, you report interest in the year you actually receive it or when it is considered received under the “constructive receipt rule.” If you are on the accrual basis, you report interest when it is earned, whether or not you have received it.

See 4.31 for minimum interest rates required for loans and 4.18 when OID rules apply.

Where partial payment is being made on a debt, or when a debt is being compromised, the parties may agree in advance which part of the payment covers interest and which covers principal. If a payment is not identified as either principal or interest, the payment is first applied against interest due and reported as interest income to the extent of the interest due.

Interest income is not realized when a debtor gives you a new note for an old note where the new note includes the interest due on the old note.

If you give away a debtor’s note, you report as income the collectible interest due at the date of the gift. To avoid tax on the interest, the note must be transferred before interest becomes due.

Filing Tip

Lost Deposits

If you lose funds because of a financial institution’s bankruptcy or insolvency, and you can reasonably estimate such a loss, you may deduct the loss as a nonbusiness bad debt, as a casualty loss, or as a miscellaneous itemized deduction (18.5).

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