Investors look to earn as much income from their investments as they can. But investment income is taxable, and so there's value in looking for deductions that can offset some of that liability. If you use margin loans or other financing methods to raise money that you use to invest, then you might be able to deduct all or part of the investment interest that you pay. With the help of this investment interest deduction calculator, you can get a better sense of whether you can write off the interest expenses you incur while investing. Let's look more closely at how the investment interest expense deduction works and how the calculator can help give you more information about it.
The rules for deductible investment interest expenses
In general, investment interest expense is deductible if you borrow money to buy property that you hold for investment. If you intend for the property to produce interest, dividends, royalties, or other flows of income that aren't connected to a trade or business, then it's considered a property you hold for investment. In addition, you can invest in a trade or business as long as you don't materially participate in that trade or business. Therefore, if you borrow money to buy such an investment, the interest you pay will be investment interest expense.
However, investment interest expense is only deductible to the extent that you have investment income for the tax year in question. If you don't have enough investment income to use up all of your expenses, then you can carry forward any unused deductible investment interest expense to future tax years. In addition, you have to itemize deductions in order to claim investment interest expense.
Also, note that there's a special rule concerning qualified dividends and net capital gain. The tax law typically doesn't include qualified dividends or net capital gain as investment income for purposes of this deduction, because these forms of income already have a lower tax rate than other types of income. However, you can elect to treat qualified dividends or net capital gain as being available to deduct investment interest expense against.
How to use the calculator
The investment interest expense calculator is fairly straightforward. The calculator asks for your marginal tax bracket, the amount of eligible investment income you receive, and the investment-related interest you pay. It then tells you whether you can deduct all or part of your interest expense, and what the savings will be.
For instance, if you have $3,000 in investment income and $2,500 in investment interest paid, then you can deduct all $2,500. For those in the 25% bracket, the resulting tax savings will be $625. By contrast, if you had $3,500 in investment interest expenses, then you'd only be able to take $3,000 this year, carrying forward the remaining $500.
The calculator assumes that you will elect to treat dividend and capital gains income as available to deduct investment interest expense against. If you don't intend to make that election, then you'll have to adjust the calculator's results manually.
One last thing to be careful of
In addition to the election available to taxpayers, there's one other thing the calculator doesn't handle. A special rule says that if you borrow money to buy investments that produce tax-free income, such as municipal bonds, then you can't deduct the interest on the money you borrow. This calculator doesn't make that distinction, so when you use it, be sure not to include any interest on borrowed money that goes toward investments whose income is tax-exempt.
Still, investors who borrow on margin or otherwise get financing for their investment activities will be happy about being able to use the investment interest deduction. By offsetting your income, claiming investment interest expenses can help reduce your tax bill significantly.
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