Investment Interest Expense

An investment interest expense is any amount of interest that is paid on loan proceeds used to purchase investments or securities. Investment interest expenses include margin interest used to leverage securities in a brokerage account and interest on a loan used to buy property held for investment. An investment interest expense is deductible within certain limitations.

An investment interest expense deductible is limited to the amount of investment income received, such as dividends and interest. If an investment is held for both business and personal gain, then any income received must be allocated proportionately between them. Personal investment interest expense is reported on Schedule A of the 1040.

A common example of this type of expense is the application of proceeds from a margin loan, taken out with a brokerage, in order to purchase stock.

A key aspect of investment interest expense is the property held for investment, which the proceeds from the loan were used to purchase. According to the tax code, this includes property that produces a gain or a loss. In addition to interest and dividends, this can also include royalties that were not derived from the ordinary course of trade or business.

There are a variety of limitations on the deductions that can be claimed on investment interest expenses. The deduction may not be claimed if the proceeds from the loan went towards property that generates nontaxable income, such as tax-exempt bonds. The deduction on investment interest also cannot be larger than the investment income that was earned that year. It is possible for such an excess to be carried forward into the next year’s tax filing.

The investment cannot have been made toward a so-called passive venture – for instance, if a taxpayer took out a loan to invest into a business they own but they do not take an active, material role in managing that business. The interest on that loan would not qualify as an investment interest expense. Likewise, if the loan was put toward acquiring a rental property, this deductible could not be claimed against the interest paid on that loan. Under the tax code, renting a house or other property is typically deemed as a passive activity; the interest expense for such an investment would not qualify for such a deductible.

It could be possible, however, to claim an investment interest expense if a taxpayer took out a loan against the equity in their residence, and then used those proceeds towards an investment in stock.