Investment Interest Expenses: Are They Taxable?

Investment interest expenses are any amount of interest that is paid on loan proceeds used to purchase investments or securities. They are tax-deductible in some circumstances, but not when used for passive ventures, such as investing in a business that the taxpayer owns but does not actively manage. There are a variety of limitations on the deductions that can be claimed on investment interest expenses. For example, the deduction may not be claimed if the proceeds from the loan went towards a property that generates non-taxable income, such as tax-exempt bonds.

Investment interest expenses are tax-deductible in some circumstances

If an investment is made for both personal and business gain, income and expenses must be allocated proportionally. Investment interest expenses are not tax-deductible when used for passive ventures, such as investing in a business that the taxpayer owns but does not actively manage. The deduction may also not be claimed if the proceeds from the loan went towards a property that generates nontaxable income, such as tax-exempt bonds.

The amount that can be deducted is capped at net taxable investment income for the year. Any leftover interest expense gets carried forward to the next year and can be used to reduce taxes in the future. Interest expense incurred by a trader who materially participates in the trading activity is not subject to the investment interest expense limitations.

Investment interest expenses are not deductible when used for passive ventures

Investment interest expenses are any amount of interest that is paid on loan proceeds used to purchase investments or securities. They are tax-deductible in some circumstances, but not when used for passive ventures, such as investing in a business that the taxpayer owns but does not actively manage. For example, if a taxpayer has a home-equity loan that they use to purchase taxable investment securities, they can use the tracing rules of Temp. Regs. Sec. 1.163-8T to classify the interest as investment interest.

The amount that can be deducted is capped at the net taxable investment income for the year. Any leftover interest expense gets carried forward to the next year and can be used to reduce taxes. To determine the deductible investment interest expense, you need to know your net investment income, which normally includes ordinary dividends.

Qualified dividends that receive preferential tax treatment aren't considered investment income for these purposes. However, you can opt to have your qualified dividends treated as ordinary income. In the right circumstances, electing to treat qualified dividends as ordinary income can increase your investment interest expense deduction, which could allow you to pay 0% tax on the dividends instead of the 15% or 20% tax that qualified dividends normally receive.

In addition to interest and dividends, investment interest expenses can also include royalties that were not derived from the ordinary course of trade or business. There are a variety of limitations on the deductions that can be claimed on investment interest expenses. The deduction may not be claimed if the proceeds from the loan went towards a property that generates nontaxable income, such as tax-exempt bonds.

Limitations on the deductions that can be claimed on investment interest expenses

There are a number of limitations on the deductions that can be claimed on investment interest expenses. The deduction may not be claimed if the proceeds from the loan went towards a property that generates non-taxable income, such as tax-exempt bonds. The deduction on investment interest also cannot be larger than the investment income earned that year. It is possible for such excess to be carried forward into the next year's tax filing. The investment cannot have been made towards a so-called passive venture, such as a business the taxpayer owns but does not take an active, material role in. Interest incurred from a 'passive activity' investment generally does not qualify for the investment interest deduction.

Investment interest is deductible as an itemized deduction but is limited to net investment income. Net investment income is defined as the excess of investment income over investment expenses. Investment income includes gross income from property held for investment, the excess of any net gain over any net capital gain resulting from the disposition of investment property, and as much of the taxpayer's qualified dividend income and net capital gain from the disposition of investment property as they elect to include. An expense subject to the 2% of adjusted gross income (AGI) limitation on miscellaneous itemized deductions is considered only to the extent a deduction is allowed.

Interest expense incurred by a trader who materially participates in the trading activity

Investment interest expenses are any amount of interest that is paid on loan proceeds used to purchase investments or securities. They are tax-deductible in some circumstances, but not when used for passive ventures, such as investing in a business that the taxpayer owns but does not actively manage. For example, if funds from a home-equity loan are used to purchase taxable investment securities, the taxpayer can consider using the tracing rules of Temp. Regs. Sec. 1.163-8T to classify the interest as investment interest.

The amount that can be deducted is capped at net taxable investment income for the year. Any leftover interest expense gets carried forward to the next year and can be used to reduce taxes. To determine the deductible investment interest expense, net investment income must be calculated. This normally includes ordinary dividends, but qualified dividends can be treated as ordinary income in the right circumstances.

The amount that can be deducted is capped at net taxable investment income for the year

Investment interest expenses are any amount of interest that is paid on loan proceeds used to purchase investments or securities. This includes margin interest used to leverage securities in a brokerage account and interest on a loan used to buy property held for investment.

Investment interest expenses are tax-deductible in some circumstances, but not when used for passive ventures, such as investing in a business that the taxpayer owns but does not actively manage. The amount that can be deducted is capped at net taxable investment income for the year. Any leftover interest expense gets carried forward to the next year and can be used to reduce your taxes.

For example, if Mary has $2,000 of qualified dividends, she would normally pay $300 in tax ($2,000 x 15% long-term capital gains tax rate). However, by electing to treat qualified dividends as ordinary income, she can increase her investment interest expense deduction and pay 0% tax on the dividends instead of the 15% or 20% tax that qualified dividends normally receive.

There are a variety of limitations on the deductions that can be claimed on investment interest expenses. The deduction may not be claimed if the proceeds from the loan went towards a property that generates nontaxable income, such as tax-exempt bonds. Interest expense incurred by a trader who materially participates in the trading activity is not subject to the investment interest expense limitations.

Frequently asked questions