The Investment Interest Expense Deduction

Let’s say you take out a $10,000 loan against your home equity to purchase stock. The interest you pay against that loan is an investment interest expense. Investment interest expense is interest paid or accrued on a loan or part of a loan that is allocable to property held for investment.

The IRS defines property held for investment as:

Property that produces income, not derived in the ordinary course of a trade or business, from interest, dividends, annuities, or royalties. It also includes property that produces gain or loss, not derived in the ordinary course of a trade or business, from the disposition of property that produces these types of income or is held for investment. However, it doesn't include an interest in a passive activity.

If you itemize your deductions on your tax return, this expense can be calculated on Form 4952 and deducted on Schedule A of you Form 1040. Your investment interest expense deduction is limited to your net investment income.

If you paid or accrued interest on a loan and used the loan proceeds for more than one purpose, you may have to allocate the interest. This is necessary because different rules apply to investment interest, personal interest, trade or business interest, home mortgage interest, and passive activity interest.

Interest incurred for an investment in a "passive activity" generally doesn't qualify for the investment interest deduction. A passive activity is a business or trade in which you hold an ownership interest but in which you don't actually participate.

Any unused investment interest deduction can be carried forward to future years. The deduction can also apply to trust and estate returns, as well as most most state income tax returns. In California, for example, the deducible amount of an investment interest expense is calculated on Form 3526.

This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.