John Bullis: Investment Interest Expense Deduction

Some individual taxpayers are allowed a special interest expense itemized deduction. It’s called Investment Interest Deduction and is figured on form 4952.

If you want an illustration of the complexities of income tax law, just print out form 4952 with the instructions. What a mess!

Most folks will have investment income only from ordinary dividends, interest income and in some instances amounts shown on a Schedule K-1 from a partnership or S corporation.

Lots of definitions are involved in the computation of the deductible amount and/or the carryover to the next year.

Basically, it’s interest that’s not paid for the loan on your home. It’s not for interest that’s related to a passive trade or business or a rental you don’t materially participate in. It’s also not for interest paid to own tax-exempt bonds. Construction interest that’s to be capitalized (added to the cost of construction) isn’t investment interest either. There are some other items that don’t qualify as investment interest that are listed in the Specific Instructions to form 4952.

The deduction is limited to your investment income. There are limitations or what qualifies as investment income for this particular deduction. Income from a trade or business isn’t investment income. Ordinary dividends are investment income except not if it’s Alaska Permanent Fund dividends. Schedule K-1 forms from a partnership, S corporation, estate or trust will list investment income that’s allowed in the computation. Net gains from sale of property held for investment, such as stocks and bonds, qualify as investment income, subject to some special computations. Capital gain dividends, as shown on form 1099-DIV qualify. The instructions have some additional items that hopefully is on items you don’t have.

There’s a special election we have used seldom where you choose to not claim the reduced tax rate on qualified dividends and long-term capital gains. Instead you choose to have those items taxed at regular tax rates (higher rates) so you have investment income that allows you to claim investment interest expense. That can be helpful when you have a lot of investment interest expense and/or a carryover from the prior year. You get to do various special “worksheets” to make that election.

Interest expense related to a passive activity is generally not allowed if you don’t materially participate in the activity (working interest in an oil or gas property, etc).

Did you hear, “Teaching kids to count is fine, but teaching them what counts is best.” — Bob Talbert

John Bullis is a certified public accountant, personal financial specialist and certified senior adviser who has served Carson City for 45 years. He is founder emeritus of Bullis and Company CPAs.


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