Learn more about how to qualify to claim investment interest expenses on your tax return.
What Is Investment Interest?
Investment interest is interest paid on a loan that you used to purchase an investment property. Investment properties include property that produces dividends, interest, royalties, or annuities that don’t come from your ordinary business. Investment properties are also properties that produce losses or gains when you sell or trade them. In other words, if you take out a loan to buy stocks, interest on that loan can be deducted as investment interest. Investment interest can also be deducted for high earners who calculate the 3.8% Net Investment Income Tax on net investment income.
How To Calculate Your Investment Income
For tax purposes, your investment income is your investment income minus investment expenses (other than any interest expenses). Investment income can include (but is not limited to) interest payments, dividends, capital gains, and rental income. If you live in Alaska, Permanent Fund Dividends are an exception. They are not considered a form of investment income. Investment expense deductions can include:
Accounting or legal fees Fees for automatic investment services Fees investment advice Safe deposit box costs
Once you’ve totaled up all your expenses, subtract that figure from your income. This number is your net investment income.
The Capital Gains Election
When you calculate net investment income for the year, you can elect to include qualified dividends and net capital gains. To do this, choose how much of your qualified dividends and net capital gains you want to include in net investment income on line 4(g) of Form 4952. Any qualified dividends and net capital gains that you include as net investment income are taxed at ordinary tax rates, not at the lower long-term capital gains tax rates. This means you will pay more tax on your capital gains. But in exchange, you could have higher net investment income, which means a higher deduction for investment interest. A tax advisor can help you decide which is the better choice to make. This election must be made on a “timely filed” tax return—that is, a return that’s filed by Tax Day (or the extended due date for the year, if you requested an extension). Taxpayers can amend a previously filed return to make this election within six months of the original due date. After it’s made, the election can be revoked only with the consent of the Internal Revenue Service.
How To Claim the Deduction
Investment expenses are a deduction on Schedule A of Form 1040. You may have to include Form 4952 as well. You don’t have to file Form 4952 if you meet all the following tests:
Your investment interest expense isn’t more than your investment income from interest and ordinary dividends minus any qualified dividends.You don’t have any other deductible investment expenses.You don’t have carryover investment interest expenses from the previous year.
You can deduct all your investment interest if you meet all three of these qualifications.
You Must Forgo the Standard Deduction
When you file your tax return, you have to choose between itemizing or claiming the standard deduction. You can’t do both. Itemizing only makes sense if the total of all your itemized deductions is higher than the amount of the standard deduction you can claim. The TCJA increased standard deductions significantly, so this might be a high hurdle to clear. If the total of all your itemized deductions isn’t more than your standard deduction, you can still choose to itemize. But you’ll end up paying more income tax than you would otherwise need to.
