The corporation must also capitalize any interest on debt allocable to an asset used to produce designated property. A shareholder may have to capitalize interest that the shareholder incurs during the tax year for the production expenditures of the S corporation. Similarly, interest incurred by an S corporation may have to be capitalized by a shareholder for the shareholder's own production expenditures. The information required by the shareholder to properly capitalize interest for this purpose must be provided by the corporation on an attachment for line 23 of Schedule K-1. Generally, interest expense is allocated in the same manner as debt is allocated.
Debt is allocated by tracing disbursements of the debt proceeds to specific expenditures.
1.163-8T gives rules for tracing debt proceeds to expenditures. Prepaid interest, which generally can only be deducted over the period to which the prepayment applies. Limit the interest deduction if the corporation is a policyholder or beneficiary with respect to a life insurance, endowment, or annuity contract issued after June 8, 1997. Attach a statement showing the computation of the deduction. See the Instructions for Form 4562 or Pub.