What Is Interest Rate Swap Tax Treatment?
You may be aware that an interest rate swap is an
arrangement between you and a lender where you swap the balance of your current
loan with the lender. The interest rate that you have agreed to pay on this
arrangement will be the interest rate that will be applied to your outstanding
balance. The interest that you end up paying will be lower than the interest
that you would have paid if you had continued to pay on your loan as usual.
There are various situations where people benefit from interest rate swaps and
what are the tax implications involved in such swaps? In general, a tax holiday
is provided to individuals who enter into interest rate swaps as the following
is explained by the IRS. Learn more from Harbourfront Technologies.
First, the swap income tax treatment that you end up paying is treated as a taxable income in the year of receipt. This is referred to as the tax-qualified Interest. If this interest has been qualified for tax treatment, the amount of tax that you will be required to pay will depend on the amount of the interest that you paid. For example, if you were required to pay 15% of your outstanding balance in the form of a tax-qualified interest, then you would have to pay taxes on this amount. You may also have to pay taxes on the interest that you have invested in your home in the case of a sell and rent back plan.
If you are not required to pay any tax on the interest that you receive under an interest rate swap, the money that you paid in would be considered a gift, and the value of that money is non-taxable to you. This is commonly referred to as a non-taxable interest benefit. You may however have to pay capital gains tax on the money that you receive under the arrangement. On the other hand, the tax-qualified interest will be taxable.
The second area of consideration deals with the investment in fixed interest rate certificates. Under this arrangement, you swap the interest rates that you have to pay on your mortgage loan or your loan that is used for the purchase of a property. In most cases, you do not have to pay the taxes on this money. You are however required to pay the capital gains tax on the interest that you pay. This applies though only to interest that you receive from the exchange. This does not apply to the money that you pay to the lender under the mortgage for your house.
The third area of interest rate swap tax treatment involves the conversion of adjustable-rate mortgages. These are loans that come with variable interest rates. Under this arrangement, if the variable rate on the loan increases, you can convert the loan to a fixed-rate mortgage. However, this conversion will only be allowed when you end up paying more interest on the principal balance than on the adjustable interest rate portion of the loan.
There is one more option that is applicable to interest rate swaps that involve the use of interest rate swaps between the primary and the secondary markets. This can be done by the use of floating interest rates. This works in that the rate that is on your loan is temporarily adjusted in order to give you the opportunity to secure a lower rate elsewhere. Once your loan has been placed into this floating rate swap, it remains at this lower rate until the next scheduled adjustment.