Deductions for Investment Interest Expenses by Kislay Shah CPA

[Kislay Shah]

Taxpayers are constantly striving to be able to make more money. A great way to do that is by investing in assets and growing your financial portfolio. By investing, further savings are acquired by being able to reduce one’s taxable income. This is achieved because the IRS allows deductions for interest paid on investments when the money is borrowed to do so. The IRS also allows deductions from interest paid on student loans, business interest, and personal interest, and qualified residence indebtedness. However, like other tax rules each situation is unique to each individual and there are regulations that must be followed for the deduction to be applicable.

What is an Investment Interest Expense?

An investment interest expense is accrued when money is borrowed to fund an investment. The interest is accumulated when borrowing money from the lender. The interest is a set percentage that is based on the balance due and is often bundled with the monthly installment of repaying the funding. The interest that is paid is the investment interest expense.

Any interest accrued from investment that will produce income or that will appreciate is able to be included in this tax deduction. However, it does not include interest from an investment if it provides nontaxable income. It also does not include any interest paid over the income amount yielded from investment. If there is interest expense over the investment income, then it can be utilized in the next tax year for deduction. Also, any investment interest expense that ensues from passive activities typically does not qualify for deduction either. A passive activity is seen as a business activity in which there is ownership interest but no active participation in the daily activities of running the business. Furthermore, if numerous investments are utilized from one debt (loan), the interest must be utilized for the same investment and filed accordingly.

Business investment interest expenses follow the same general guidelines but do become more involved. Business investment interest expenses that are deductible are those that arise from a loan or debt taken to produce income. The deduction is only allowed if the business can show that it derived a business purpose from the loan or debt. The deduction is maxed out at a rate determined by the interest income, 30% of the taxable income, and its floor plan financing income. Anything that is over the determined rate can be carried forward until it is utilized. These business limitations are not applicable to small businesses. This is defined as those with gross receipts of $25,000,000 or less for a three-year period.

Claiming Interest Expense

In order to capitalize on your interest expenses, taxes must be itemized, and investment interest expenses are to be listed under Schedule A on Form 1040. Form 4952 may also have to be filed if certain circumstances are met. Only taxpayers that are solely deducting the investment interest expense, do not have a carryover of interest deduction from a prior year, nor have an interest expense that exceeds the investment’s income with interest and dividends do not have to file Form 4952. Filing Form 4952 is straightforward. It consists of three segments. The first section is the total investment interest expenses accrued. Section two consists of the gross income from the property for investment, and section three will calculate the interest amount that is over your deduction amount that will have to be utilized in the following year.

To ensure that your tax forms are filed correctly, it is best to have assistance from a certified accountant. While regulations and guidelines do tend to stay consistent at their root, they do change. For example, in 2017, the Tax Cuts and Jobs Act temporarily changed the rules for investment interest deductions. So, after 2017, when calculating net investment income to configure the deduction, interest expenses are no longer included. This change was in effect from 2018 to 2025 and applied to individuals, trusts, and estates. Additionally, there were other changes made to the tax code that affected investors, such as changes to the capital gains tax rates. These changes make it important to review and stay up to date with the latest regulations and guidelines for investment to ensure accurate calculations.

For Example

Kaitlyn has a total taxable income of $55,000. Her investment income was $5,000 and the investment interest expenses accumulated to $7,500 for the year.

When filing her taxes, Kaitlyn can deduct $5,000 from her total taxable income reducing it to $50,000. And, since Kaitlyn’s total interest expense equated to $7,500, she has a remaining expense of $2,500 that can be utilized for the following year’s taxes. She was not able to utilize the $2,500 this tax year since that amount was over her investment income.

Plan your Investments

Investments are becoming more common, and it is imperative to be able to maximize these investments to make the most out of your money. This is why consulting with a certified accountant is essential to your financial success. 

Schedule a consultation with Kislay Shah CPA to talk about the investment path that is best for you.