On December 22, 2017, The Tax Cuts and Jobs Act was signed into law. The information in this article predates the tax reform legislation and may not apply to tax returns starting in the 2018 tax year. You may wish to speak to your tax advisor about the latest tax law. This publication is provided for your convenience and does not constitute legal advice. This publication is protected by copyright.
Generally, the only interest deductible on the Schedule A (where deductions are itemized) is home mortgage interest, with one exception, investment interest. Investment interest can be interest you pay on your brokerage margin account, interest on investment property such as land, etc. However, this interest deduction is limited to “net investment income.” In layman’s terms, you can only deduct the interest expense to the extent you have investment income.
And to complicate matters further, the term “Net Investment Income” refers to investment income less any investment expenses. For example, you own vacant land and your annual property taxes on that land are $500. The property taxes are treated as investment expenses. You also have interest income of $1,200 for the year. Your net investment income is $700 (the $1,200 interest income less the $500 property tax expense). Therefore, you would be able to deduct $700 of investment interest for the year. If your investment interest exceeded the $700, the excess would carry over to the next year.
In a taxable year where there is a capital gain, the taxpayer can elect to treat any portion of that gain as investment income. If that election is made, then the taxpayer must treat the elected capital gains as ordinary income. This prevents a taxpayer from receiving the favorable capital gains tax rates and a deduction for investment interest based on the same net investment income.