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Tax issue of Paid back Principal plus appreciation linked to equity index, eg gold

Fairport, NY |

What is the IRS Tax treatment of a loan principal paid after 3 years with appreciation :
A person A loaned Principal P to B to be paid after 3 years with interest I, paid quarterly, The interest i was reported at end of year on 1099-interest and taxed accordingly.
The loan , Promissory note stipulates that its principal value is tagged/indexed to the price of Gold at the outset, and would be paid accordingly, ie if Gold is up by 20% the principal is paid back with 20% increase, and the opposite is true, ie if Gold is down by 20%, the principal is paid back with 20% decrease, so principal value is at risk. Fortunately it did increase..
Is it to be reported as Long Term Cap Gain on sched-D ? Is there any IRS ruling/opinion in that regard? -link appreciated. Thanks , Abud.

Attorney Answers 1

  1. There is no deduction for the repayment of principal on a loan. (Arguably there is an exception for ESOP loans.) What you have described is not a mere loan: it is a loan which might be characterized as either an adjustable interest element or as an equity kicker. The issue is whether the arrangement will be characterized as a loan or as a partnership. If it is characterized as a loan, then the borrower wil be entitled to deduct the entire amount of interest. If it is characterized as a partnership, then there will be no interest deduction. The analysis of the arrngement requires a review of the actual documents.

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