Most farmers borrow money to purchase operating inputs, machinery and equipment, livestock, and land. The interest paid on these business loans is a significant business expense generally reported on Lines 21a and 21b, Schedule F.
Note: For farmers with three years of average gross receipts of $26 million or more in 2021 ($27 million in 2022), the interest deduction may be limited under IRC § 163(j). The deduction is also limited if the farm business is a tax shelter. Further information on this limitation can be found in the Instructions for IRS Form 8990, Limitation on Business Interest Expense under IRC § 163(j).
Farmers report interest for business mortgages that have an associated IRS Form 1098, Mortgage Interest Statement, on Line 21a. The IRS uses this line to reconcile and match the interest reported on the Form 1098 and the Schedule F.
Note: A taxpayer may not deduct interest they pay on someone else’s behalf. In other words, farmers can only deduct interest they are obligated to pay under a loan agreement for property in which they have an ownership interest. A guarantor of a business loan is only able to deduct interest payments if the business defaults, leaving the guarantor obliged to make the payments.
Example 1. Freida has a loan with Farm Credit Services on farmland she purchased. This year Freida paid $25,000 in interest which was reported to her on Form 1098 issued by Farm Credit. Freida reports and deducts this interest on Line 21a, Schedule F. IRS will match the deduction with the Form 1098.
Farmers report interest paid on business loans not reported on a Form 1098 on Line 21b, Schedule F. The interest could be from an operating line of credit, machinery and equipment loans, or credit advanced from input providers for seed, fertilizer, and pesticides.
Example 2. Ken operates a diversified farm. This year he paid $15,000 in interest on his operating loan, $5,000 in interest on his pickup loan, and $27,000 interest on machinery and cattle loans. None of these interest amounts were reported to Ken on a Form 1098. Ken uses Line 21b, Schedule F, to report the $47,000 of interest paid.
Farmers using the cash method of accounting may not deduct prepaid interest. If the farmer makes an interest payment in one tax year for interest not due until the following year, the farmer must wait until the next tax year to deduct the prepaid interest.
Example 3. Rosita has a large vegetable and cut-flower business. This year has been exceptionally profitable and provides for a significant cash reserve. Rosita negotiates with her lender to prepay three years of projected interest expense at a locked-in rate for her operating loan. She pays $45,000 of interest, $8,000 of which is allocable to her current year’s operating loan. The remaining $37,000 is prepaid interest, which the bank will draft quarterly over the next three years. This year, Rosita is allowed to report and deduct only $8,000 of interest on her operating loan.
As noted above, only business interest is deductible on Schedule F. Other rules allow homeowners to deduct interest paid on a home mortgage on Form 1040, Schedule A, up to certain limits. Since 2018, interest paid on home equity loans is generally not deductible on Schedule A unless the proceeds are used to renovate the home. If the home equity loan is used for business purposes, however, the interest remains a deductible business expense. Farmers must be careful to trace and document the proceeds from the home equity loan to the payment of the business expense. While a home equity loan may allow for a lower interest rate, it does put the home at risk of foreclosure if the debtor defaults.
Example 4. Carlos paid off the mortgage on his home three years ago. He wants to expand his farming operation to go full-time and resign at the foundry where he currently works. Carlos can borrow $200,000 against his house, which will provide him with operating funds for his business. This year his interest expense was $6,000, which was reported to him on a Form 1098. Carlos makes the election to treat this interest as business interest and deduct it on his Schedule F; thus, it is not only a deduction against income tax but also self-employment tax. The $6,000 is reported and deducted on Line 21a, Schedule F.
The Center for Agricultural Law and Taxation is a partner of the National Agricultural Law Center (NALC) at the University of Arkansas System Division of Agriculture, which serves as the nation’s leading source of agricultural and food law research and information. This material is provided as part of that partnership and is based upon work supported by the National Agricultural Library, Agricultural Research Service, U.S. Department of Agriculture.
