This section discusses the interest expenses you may be able to deduct as an investor.
If you borrow money to buy property you hold for investment, the interest you pay is investment interest. You can deduct investment interest
subject to the limit discussed later. However, you cannot deduct interest you incurred to produce tax-exempt income. Nor can you deduct interest
expenses on straddles.
Investment interest does not include any qualified home mortgage interest or any interest taken into account in computing income or loss from a
passive activity.
Investment Property
Property held for investment includes property that produces interest, dividends, annuities, or royalties not derived in the ordinary course of a
trade or business. It also includes property that produces gain or loss (not derived in the ordinary course of a trade or business) from the sale or
trade of property producing these types of income or held for investment (other than an interest in a passive activity). Investment property also
includes an interest in a trade or business activity in which you did not materially participate (other than a passive activity).
Partners, shareholders, and beneficiaries.
To determine your investment interest, combine your share of investment interest from a partnership, S corporation, estate, or trust with your
other investment interest.
Allocation of Interest Expense
If you borrow money for business or personal purposes as well as for investment, you must allocate the debt among those purposes. Only the interest
expense on the part of the debt used for investment purposes is treated as investment interest. The allocation is not affected by the use of property
that secures the debt.
Limit on Deduction
Generally, your deduction for investment interest expense is limited to the amount of your net investment income.
You can carry over the amount of investment interest that you could not deduct because of this limit to the next tax year. The interest carried
over is treated as investment interest paid or accrued in that next year.
You can carry over disallowed investment interest to the next tax year even if it is more than your taxable income in the year the interest was
paid or accrued.
Net Investment Income
Determine the amount of your net investment income by subtracting your investment expenses (other than interest expense) from your investment
income.
Investment income.
This generally includes your gross income from property held for investment (such as interest, dividends, annuities, and royalties). Investment
income does not include Alaska Permanent Fund dividends.
Choosing to include net capital gain.
Investment income generally does not include net capital gain from disposing of investment property (including capital gain distributions from
mutual funds). However, you can choose to include all or part of your net capital gain in investment income.
You make this choice by completing line 4e of Form 4952 according to its instructions.
If you choose to include any amount of your net capital gain in investment income, you must reduce your net capital gain that is eligible for the
lower capital gains tax rates by the same amount.
Before making this choice, consider the overall effect on your tax liability. Compare your tax if you make this choice with your tax if you do not.
Investment income of child reported on parent's return.
Investment income includes the part of your child's interest and dividend income that you choose to report on your return. If the child does not
have Alaska Permanent Fund dividends or capital gain distributions, this is the amount on line 6 of Form 8814, Parents' Election To Report
Child's Interest and Dividends.
Child's Alaska Permanent Fund dividends.
If part of the amount you report is your child's Alaska Permanent Fund dividends, that part does not count as investment income. To figure the
amount of your child's income that you can consider your investment income, start with the amount on line 6 of Form 8814. Multiply that amount by a
percentage that is equal to the Alaska Permanent Fund dividends divided by the total amount of interest and dividend income on lines 1a and 2 of Form
8814. Subtract the result from the amount on line 6 of Form 8814.
Child's capital gain distributions.
If part of the amount you report is your child's capital gain distributions, that part (which is reported on line 13 of Schedule D or line 13 of
Form 1040) generally does not count as investment income. However, you can choose to include all or part of it in investment income. See chapter 3 of
Publication 550
to figure the amount to include.
Your investment income also includes the amount on line 6 of Form 8814 (or, if applicable, the amount figured under Child's Alaska Permanent
Fund dividends, earlier.
Investment expenses.
Investment expenses include all income-producing expenses (other than interest expense) relating to investment property that are allowable
deductions after applying the 2% limit that applies to miscellaneous itemized deductions. Use the smaller of:
- The investment expenses included on line 22 of Schedule A (Form 1040), or
- The amount on line 26 of Schedule A.
Losses from passive activities.
Income or expenses that you used in computing income or loss from a passive activity are not included in determining your investment income or
investment expenses (including investment interest expense). See Publication 925,
Passive Activity and At-Risk Rules, for information about
passive activities.
Form 4952
Use Form 4952, Investment Interest Expense Deduction, to figure your deduction for investment interest.
Exception to use of Form 4952.
You do not have to complete Form 4952 or attach it to your return if you meet all of the following tests.
- Your investment interest expense is not more than your investment income from interest and ordinary dividends.
- You have no other deductible investment expenses.
- You have no disallowed investment interest expense from 2000.
If you meet all of these tests, you can deduct all of your investment interest.
More Information
For more information on investment interest, see Investment Expenses in chapter 3 of Publication 550.
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