734 / Is interest deductible?

Editor’s Note: The 2017 Tax Act limited the mortgage interest deduction to $750,000, so that from 2018-2025, only interest on up to $750,000 of new mortgage debt may be deducted. This limit applies to debt incurred after December 31, 2017 and before January 1, 2026.¹ After December 31, 2025, absent Congressional action to extend the current rules, the $1 million mortgage interest deduction will be reinstated and will apply regardless of when the taxpayer incurred the relevant debt (see Q ).² Modifications to the deductibility of business interest are discussed in Q to Q .

Editor’s Note: Late in 2015, Congress acted to extend the treatment of certain mortgage insurance premiums as qualified residence interest, as discussed below, through 2016. This treatment was extended through 2017 by the Bipartisan Budget Act of 2018, again through 2020 by the SECURE Act and through 2021 by CAA 2021 as of the date of this publication.

The deductibility of interest depends on its classification, as described below. Furthermore, interest expense that is deductible under the rules below may be subject to the additional limitation on itemized deductions (unless it is investment interest, which is not subject to that provision). Interest must be classified and is deductible within the following limitations:

(1) Investment interest. This includes any interest expense on indebtedness properly allocable to property held for investment.³ Generally, investment interest is deductible only to the extent of investment income; however, investment interest in excess of investment income may be carried over to succeeding tax years. For purposes of this calculation, net long-term capital gain income is included in investment income if the taxpayer foregoes the reduced tax rate (0 percent/15 percent/20 percent) that applies to such income. Under JGTRRA 2003, as extended by ATRA, certain dividends are taxable at the lower capital gains rates rather than at higher ordinary income tax rates. A dividend will be treated as investment income for purposes of determining the amount of deductible investment interest income only if the taxpayer elects to treat the dividend as not being eligible for the reduced rates.⁴ For the temporary regulations relating to an election that may be made by noncorporate taxpayers to treat qualified dividend income as investment income for purposes of calculating the deduction for investment interest, see Treasury Regulation Section 1.163(d)-1.⁵ Note that the 2017 tax reform legislation placed limitations on the deductibility of business interest, which specifically excludes investment interest.

(2) Trade or business interest. This includes any interest incurred in the conduct of a trade or business. Generally, such interest was deductible as a business expense prior to 2018. See Q for a discussion of the treatment of corporate business interest under the 2017 tax reform legislation. Q and Q outline the new rules as they apply to pass-through entities.⁶