Investment Interest Many of our clients are often confused when
the subject of "deductible" interest is brought up. Many years ago, all interest
(yes, for you younger readers, even credit card and auto loan interest) was
available as an itemized deduction on your personal return.
However, after that law was
changed and personal interest made nondeductible, many people do not realize
that "investment interest" (interest paid on money borrowed to purchase property
held for investment) is still deductible.
Investment property is any property held for investment
including property that produces interest, dividends, annuities, royalties or
gains on disposition (land, etc). Investment property cannot be associated with
a trade or business. Investment property is not limited to, but would include
▪ Corporate stock
▪ Bonds and notes
▪ Mutual funds
▪ Any interest in a trade or business in which you do not materially participate
Limits On Deductibility
As with all interest deductions, investment interest must
actually be "paid" during the year you intend to deduct it. Even if your broker
has charged margin interest to your account, you cannot deduct that interest
until the brokerage has actually taken the money from your account balance.
Also, you cannot prepay interest on an
investment for future years and take the deduction. You may only take the
investment interest deduction in those years that the interest has actually
Investment interest is also deductible only to the extent that it
offsets net investment income. Unfortunately, this rule tends to limit a lot of
our clients in being able to deduct all of their investment interest.
example, if you borrow $20,000 to purchase a particular stock that your buddy
has sworn is going to explode in value, you may find yourself unable to deduct
the interest on that loan if you do not have sufficient interest and dividends
or other investment income to warrant the deduction.
Net investment income
means income net of any expenses incurred to obtain it. That means that even if
you have interest and dividends, your net investment income that you can use to
offset investment interest will be limited by any investment fees, publication
expenses, etc that you incurred for the year.
interest can be carried over to following years so, in the example above, you
could eventually offset the accumulated investment interest expense if you
eventually sold the acquired stock at a gain large enough to offset it.
Investment interest also cannot be deducted if it is interest on money borrowed
to acquire or hold property that produces tax-exempt income. The most common
tax-exempt properties would be municipal bonds or mutual funds that hold
Allocation Of Your Investment Interest Expense
problem that most clients run into is the allocation of their interest expense
between investment interest and personal interest. If you have borrowed money
for both personal and investment purposes, you must allocate the debt and
resulting interest expense among these different purposes.
For example, if
you borrow $10,000 and use $5,000 of the proceeds to purchase mutual funds and
$5,000 to acquire a boat, only half of your interest expense from that debt will
be allowed as investment interest.
Unfortunately, it's seldom that easy in
determining the proper allocation to make. For instance, if you later sell all
or a portion of the stock you acquired with the debt and use the funds for
personal or other reasons, the interest on the original debt will no longer be
eligible as investment interest.
Since many of our clients often move money
around between accounts and for different purposes, the allocation of investment
interest can get complicated very quickly.
There are steps you can take to
ensure that your deduction is "clean" and not subject to challenge by the IRS.
These steps involve setting up separate accounts, proper tracking and moving the
money in a way that leaves no question as to how its being used.
contact us in advance if you have investment loans that you would like to use
for other purposes. There are also many strategies you may be able to take
advantage of if you have investment interest and potential capital gains to
offset them. We can assist you in working through some of the pitfalls and