If you borrow money to buy property you hold for investment (such as bonds or certain securities), the interest you pay is considered investment interest. Your investment interest expense my be subject to certain limitations. Generally, you can only deduct investment interest up to the amount of your net investment income. The amount of investment interest that you cannot deduct this year can generally be carried forward to be deducted on next year's tax return.
Investment property includes property that produces income from interest, dividends, annuities, or royalties. For it to qualify as investment property, this income should not be income that is derived in the ordinary course of a trade or business. It also includes property that produces gain or loss from the sale or trade of property producing these types of income. Investment property also includes an interest in a trade or business activity in which you did not materially participate (other than a passive activity).
What interest CANNOT be deducted?
Investment interest expense does not include any of the following:
- Home mortgage interest
- Interest expense that is properly allocable to a passive activity. Generally, a passive activity is any trade or business activity in which you do not materially participate and any rental activity.
- Any interest expense that is capitalized, such as construction interest subject to section 263A.
- Interest expense related to tax-exempt interest income under section 265.
- Interest expense, disallowed under section 264, on indebtedness with respect to life insurance, endowment, or annuity contracts issued after June 8, 1997, even if the proceeds were used to purchase any property held for investment.
For more information on Investment Interest Expenses, please reference this IRS Publication 550.