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Q1: How do we report the interest being paid to the lender and what does the lender use to report on his taxes?
A1: The person or business to whom the mortgage interest is being paid is the party that issues the Form 1098, not the person paying the interest. As you and your wife pay the interest, your friend, the lender should issue you a Form 1098. The Form 1098 will serve as his proof of income, and the Form 1098 serves as proof that you paid the interest.
In the section of the Form 1098 where it asks for recipient's federal identification number, the E.I.N. of the LLC is listed there. The Recipient is the name and address of the LLC. Again, you don't issue the form to your friend, the lender, he issues it to the LLC.
Let me know if you require further assistance with this matter.
I see in the Form 1098 instructions that it is not necessary to issue a Form 1098 to a partnership. The partnership will complete the Form 8825 and report the interest paid on it. If your friend, the lender is set up as an S-Corp, he can also use the Form 8825 to report the interest income.
Link to Form 8825/instructions:
If your friend is not set up as an S-Corp, you can issue him a Form 1099-Misc. and report the interest amount paid to him in box 3 as Other Income. You file a copy of the 1099-Misc with the IRS, give him a copy and you keep a copy. As you will complete the Form 8825 and the Form 1099-Misc, to make sure that the IRS does not get confused, you may also want to complete a disclosure statement, Form 8275 to explain that the amount shown on the Form 8825 and 1099-Misc relate to the same interest paid and the interest shown on these forms should not be counted twice.
Link to Form 8275:
Link to Form 1099-Misc:
Let me know if you require further clarification.