If you borrow money to purchase an investment, you may qualify for a tax break. The IRS allows certain taxpayers to take a tax deduction for the interest expense on some loans using Form 4952. However, the tax ramifications of investment interest can be complicated, as the IRS only allows a deduction for certain types of investment interest. Additionally, the Alternative Minimum Tax (AMT) could completely disallow the use of your investment interest deduction.
Key Takeaways
- Form 4952 is used to claim a tax deduction for your investment interest expenses.
- The form requires you to calculate your total investment interest expense, determine your net investment income, and figure out any disallowed investment expense that can be carried forward.
- You might not be able to use the investment interest deduction if you're subject to the Alternative Minimum Tax (AMT).
- Only certain types of investment interest qualify for the deduction, and the amount that you can deduct is limited to the amount of your net investment income.
Investment interest expense and income
One of the most common examples of investment interest expense involves the use of a margin loan at a brokerage. If you "go on margin" with your stockbroker, it means you're borrowing money from the firm to buy stocks or other investments. The interest you pay on that margin loan is qualifying investment interest.
You can only take a deduction for investment interest expenses that is lesser than or equal to your net investment income. For example, if you have $3,000 in margin interest but net investment income of only $1,000, you can only deduct the $1,000 in investment interest in the current year.
The IRS does allow you to carry forward the disallowed deduction into future years, however. In this example, you can use the $2,000 in disallowed expenses for this year in a future year, but the same restrictions continue to apply. You must have net investment income to deduct qualifying investment interest.
Investment interest expense limitations
Not all interest you pay on investment loans is allowed as a deduction. The IRS specifically prohibits certain types of investment interest from qualifying, including the following:
- qualified home mortgage interest
- interest used to generate tax-exempt income, such as if you go on margin to buy a municipal tax-free bond
- option straddles, which are an advanced investment strategy not applicable to most investors
- interest taken into account when computing the gain or loss on any passive activities
Alternative Minimum Tax (AMT)
Thanks to the Alternative Minimum Tax, if you fill out one Form 4952, you'll always have to complete a second one for AMT calculations. The AMT is designed to ensure that certain individuals pay at least a minimum amount of tax by adding back in items that may have been excluded from a traditional tax calculation.
Investment interest is one of those deductions disallowed under the AMT. The instructions for Form 4952, "Investment Interest Expense Deduction," and Form 6251, "Alternative Minimum Tax—Individuals," instruct taxpayers on how to compute the correct taxes under both systems. Ultimately, whichever of your Form 4952s shows the higher tax is the one you will have to file with the IRS.
TurboTax Tip:
Typically, the amount of investment interest expense that exceeds your deductible amount can be carried forward to future tax years.
Using Form 4952
Although the rules for calculating investment interest expense deductions may be complicated, Form 4952 itself is quite short and divided into these three sections:
- Part I consists of three lines on which you'll calculate your total investment interest expense
- Part II is where you'll enter your gross income from property held for investment; after a few adjustments outlined in the instructions for the form, you'll arrive at your net investment income on line 6
- Part III serves two purposes—calculation any disallowed expense that you can carry forward to future years and determining your net investment interest expense deduction for the current year on line 8. This final amount is what you transfer to Schedule A to be used as an itemized deduction on your taxes.
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FAQs
Form 4952: Investment Interest Expense Deduction is a tax form distributed by the Internal Revenue Service (IRS) used to determine the amount of investment interest expense that can be deducted, as well as any interest expense that can be carried forward to a future tax year.
What is the form 4952 investment interest expense? ›
Use Form 4952 to figure the amount of investment interest expense you can deduct for 2023 and the amount you can carry forward to future years. Your investment interest expense deduction is limited to your net investment income. For more information, see Pub. 550, Investment Income and Expenses.
What is investment interest expense deduction? ›
The deduction applies to interest on money borrowed to buy property that will produce investment income—interest, dividends, annuities or royalties—or that you expect to appreciate in value, allowing you to sell it at a gain in the future.
How does interest expense deduction work? ›
Generally, for loan interest to be deductible, the loan must be used to either purchase assets for the business or to pay for business expenses. 2 If any amount of the loan is used for nonbusiness purposes, then the amount of deductible interest from the loan must be reduced proportionately.
How many years can you carry forward investment interest expenses? ›
Any excess investment interest expense that is disallowed is carried forward indefinitely until net investment income is recognized. Form 4952 is used to determine the investment interest expense deduction.
Is interest on investment expense or income? ›
The interest accrued on a basic savings account is considered investment income. It is earned on top of the original investments—the deposits placed into the account—which can make the account a source of income. Options, stocks, and bonds can also generate investment income.
Can I deduct investment management fees? ›
The implementation of the TCJA brought significant changes for investors in terms of tax deductions, policies, rates, and credits. Now, the law doesn't allow deductions of investment management fees and other related expenses.
What are the rules for deducting interest expense? ›
You must pay the interest during the year in which you are claiming the deduction. Note that compound interest (interest on your interest) is only deductible in the year it is actually paid. 3. There must be a legal obligation pay the interest.
What is an example of interest expense tax-deductible? ›
Several types of interest are tax-deductible, including mortgage interest on a primary or second home, student loan interest, and interest on some business loans, including business credit cards.
How much is the allowable deduction for interest expense? ›
The interest shall be reduced by an amount equivalent to twenty percent (20%) of the interest income subjected to final tax. However, if the final withholding tax rate on interest income of twenty percent (20%) is adjusted in the future, the interest reduction shall be adjusted accordingly.
Investment interest expense
The amount that you can deduct is capped at your net taxable investment income for the year. Any leftover interest expense gets carried forward to the next year and can potentially be used to reduce your taxes in the future.
What investment expenses are not deductible? ›
Amounts paid for financial planning are generally not tax deductible. These include fees paid to an advice-only financial planner (i.e., one who doesn't deal in specific investments).
What qualifies as investment expenses? ›
Investment expenses are amounts you pay to produce or collect taxable income, or to manage, conserve, or maintain your investments.
What is Schedule E investment interest expense? ›
Investment interest expense is claimed as an itemized deduction on Schedule A (Form 1040). However, the portion of deductible investment interest expense attributable to royalties is claimed on Schedule E (Form 1040).
What is tax-exempt investment interest? ›
Tax-exempt interest refers to interest income that is not subject to taxation, most notably at the federal level. Some municipal bonds may also be "triple-exempt", where tax is not paid at the federal, state, nor local level.
What is the code section for investment interest expense? ›
§163(d), Limitation on Investment Interest
The term “investment interest” means any interest allowable as a deduction under this chapter (determined without regard to paragraph (1)) which is paid or accrued on indebtedness properly allocable to property held for investment.
What is the tax interest expense? ›
An interest expense is an accounting item that is incurred due to servicing debt. Interest expenses are often given favorable tax treatment. For companies, the greater the interest expense the greater the potential impact on profitability. Coverage ratios can be used to dig deeper.
