Investment Interest Expenses – Form 4952

Both of these apply to investment interest:

  • It’s interest on money you borrow specifically to buy investments like:
    • Stocks
    • Non-tax-exempt bonds
    • Land or other investment property
  • You hold these investments to yield taxable income.

This doesn’t include straddles or anything that yields tax-exempt income, like:

  • Municipal bonds
  • Life insurance
  • Annuities

If the loan on stock comes from a broker, it’s usually a margin account.

You might have used part of a home-equity loan or line of credit to buy the investment. If you did and you can deduct it as home-mortgage interest, don’t count the loan interest as investment interest. Also, investment interest doesn’t include interest related to a passive activity.

You might borrow money and use only part of it for investment purposes. If so, you must allocate the interest between the various uses. The allocation is based on how much of the loan is used for each purpose.

You usually can’t deduct:

  • Interest you haven’t paid
  • Prepaid interest

You might know how much interest you’ll be paying. Even so, you can’t deduct that interest if it applied to a loan you had during the year.

Rules exist limiting the amount of investment interest you can deduct. The investment interest you can deduct can’t be more than the net investment income you report. For this, net investment income is investment expenses you subtract from items like:

  • Interest
  • Dividends
  • Short-term capital gains
  • Royalties

You usually can’t include qualified dividends or long-term capital gains as investment income. You’re already getting a tax break on them since they’re taxed at a lower rate than most income. The lower rate might be 0%, 15%, or 20%, depending on your tax bracket. You might also have a 3.8% net investment income tax (NIIT) if both of these apply:

  • Your modified adjusted gross income (AGI) is more than:
    • $200,000 for single
    • $250,000 for married filing jointly
    • $125,000 for married filing separately
  • You have net investment income.

However, when you prepare your taxes, you can designate these types of income as investment income:

  • Qualified dividends
  • Long-term capital gains

Then, you can include this amount when figuring your net investment income. However, you won’t receive the lower tax rates that those receive. They’ll now be taxed at the same rate as all your other income. The advantage of this is that you’ll be able to deduct more investment interest.

You don’t have to allocate any qualified dividends or long-term gains to ordinary income. If you don’t, you can carry over any investment interest expense you couldn’t use. You need to decide which option will lower your taxes over a period of time.

You deduct investment interest on Schedule A with your other itemized deductions. To deduct investment interest, you must file a Form 4952 with your return. On this form, figure these:

  • Amount of investment interest you can deduct
  • Amount of investment income to carry over to future years, if any

This is where you designate the amount of qualified dividends and long-term capital gains you want to treat as investment income. To learn more, see Publication 550: Investment Income and Expenses at www.irs.gov.

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