Joe, a cash basis taxpayer, took out a 12-month business loan on December 1, 2017. He prepaid all $3,600 of the interest on the loan on December 1, 2017. Joe can deduct only $300 of the prepaid interest in 2017.

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As a cash basis taxpayer, Joe can only deduct expenses that are actually paid during the tax year. Since he prepaid all $3,600 of the interest on December 1, 2017 but the loan extends for 12 months, he can only deduct the portion of the prepaid interest that applies to the month of December 2017: $3,600/12 months = $300 deductible in 2017. The remaining $3,300 will be deductible in 2018, as long as Joe continues to be in business and the loan remains outstanding.

Joe, a Cash Basis Taxpayer, Took Out a 12-Month Business