NEW YORK (MainStreet) — You may know that any losses on your investments are deductible, but did you know that you can deduct interest paid on money you borrow to purchase those investments? Qualified investments include property that produces taxable interest, dividends, or royalties, or will produce gain or loss when sold - such as stocks and bonds, mutual fund shares, limited partnership units, or real estate. The most common type of deductible investment interest is “margin interest” charged on a brokerage account.
The current deduction for investment interest is limited to net investment income. This includes taxable interest, “non-qualified” dividends (dividends that do not qualify for the special lower capital gains tax rates), royalties, and net short-term capital gains. Net long-term capital gains are not considered investment income for purposes of deducting investment interest because they are subject to the special lower rates.
Deductible investment expenses, such as those allowed as a miscellaneous deduction on Schedule A, are subtracted from investment income to determine the “net investment income” limitation. Deductible investment interest is calculated on IRS Form 4952.
You can make a special election to forgo the special tax rate on “qualified” dividends and long term capital gains, and have this income taxed at ordinary income rates, to increase your current deduction for investment interest.
If your investment interest expense for the year exceeds your net investment income you can “carry forward” the excess interest and claim a deduction on a future tax return – similar to the way excess net capital losses are carried forward.