The Investment Interest Expense Deduction in 2021
Investors who borrow money to invest may be able to deduct their loan interest
The Tax Cuts and Jobs Act (TCJA) eliminated many miscellaneous itemized deductions from 2018 through at least 2025, but one deduction that wasn't eliminated was the investment interest deduction. Individual taxpayers can still claim investment interest expenses as an itemized deduction on Schedule A of their Form 1040 tax returns.
Here are the factors you need to consider if you think you might qualify to claim investment interest expenses on your returns.
What Is Investment Interest?
Investment interest is interest paid on a loan where the proceeds were used to purchase property you held for investment. According to the Internal Revenue Service, "Property held for investment includes property that produces interest, dividends, annuities, or royalties not derived in the ordinary course of a trade or business. It also includes property that produces gain or loss."
In other words, if you take out a loan to buy stocks, interest on that loan can be deducted as investment interest. Investment interest should also be deducted when high earners calculate the 3.8% Net Investment Income Tax on net investment income.
The amount of interest that can be deducted in any particular year is limited to a taxpayer's net investment income for that same year. It can't exceed that amount.
How to Calculate Your Investment Income
For tax purposes, your investment income is your investment income minus investment expenses (other than any interest expenses).
Investment income can include (but is not limited to) interest payments, dividends, capital gains, and rental income. If you live in Alaska, Permanent Fund Dividends are an exception, and they are not considered a form of investment income.
Investment expense deductions can include accounting fees, legal fees, fees for automatic investment services, fees for investment advice, and safe deposit box costs. Once you've totaled up all your expenses, subtract that figure from your income and you'll have your net investment income.
The Capital Gains Election
Taxpayers can elect to include qualified dividends and net capital gains in the calculation of net investment income for the year for the purpose of deducting investment interest. This election is accomplished by choosing how much of your qualified dividends and net capital gains you want to include in net investment income on line 4(g) of Form 4952.
The effect of this election is that qualified dividends and net capital gains included in net investment income are taxed at ordinary tax rates, not at the lower long-term capital gains tax rates. In exchange for accepting a higher capital gains rate, you could have higher net investment income, and thus, a higher deduction for investment interest.
This election must be made on a "timely filed" tax return—that is, a return that's filed by Tax Day (or the extended due date for the year, if you requested an extension). Taxpayers can amend a previously filed return to make this election within six months of the original due date. After it's made, the election can be revoked only with the consent of the Internal Revenue Service.
How to Claim the Deduction
Investment expenses are a deduction on Schedule A of Form 1040.
- Your investment interest expense is not more than your investment income from interest and ordinary dividends minus any qualified dividends.
- You do not have any other deductible investment expenses.
- You have no carryover of investment interest expense from the previous year.
You can deduct all your investment interest if you meet all three of these qualifications.
You Must Forego the Standard Deduction
Itemizing or claiming the standard deduction for your filing status is a choice—you can't do both. Therefore, itemizing only makes sense if the total of all your itemized deductions exceeds the amount of the standard deduction that you're entitled to claim. The TCJA increased standard deductions significantly, so this might be a high hurdle to clear.
For tax year 2021, the deduction for single filers is set at $12,550 (increased from $12,400 for the 2020 tax year). For married taxpayers who file jointly, it's $25,100 (increased from $24,800 in 2020). It's $18,800 for those who qualify as head of household (up from $18,650 for 2020).
If the total of all your itemized deductions isn't more than your standard deduction, and you still choose to itemize, then you'll end up paying more income tax than you would otherwise need to.
Internal Revenue Service. "Publication 550, Investment Income and Expenses (Including Capital Gains and Losses)." Accessed Nov. 16, 2020.
Internal Revenue Service. "Questions and Answers on the Net Investment Income Tax." Accessed Nov. 16, 2020.
Internal Revenue Service. "Topic No. 409 Capital Gains and Losses." Accessed Nov. 16, 2020.
Internal Revenue Service. "IRS Provides Tax Inflation Adjustments for Tax Year 2021." Accessed Nov. 16, 2020.