7919 / If an individual borrows the minimum required deposit on a certificate of deposit, is the interest expense on the loan deductible?
Generally yes (if the taxpayer itemizes deductions); however, the total amount of investment interest expense otherwise deductible by a taxpayer is subject to the limitation explained in Q 8040.
If the loan and certificates are from the same bank, the loan and deposit will, regardless of the structure of the transaction, be treated as two separate transactions for tax purposes: the interest earned on the full face value of the certificate will be reported by the bank on Form 1099-INT and must be included by the individual in gross income for the year in which the certificate matures.1 The interest paid on the loan will be subject to the limitations explained in Q 8040 (as well as the general rules for interest deductions (see Q 8027 through Q 8046)) and may be deducted only if the individual itemizes deductions on the income tax return for the year.
Example. Dr. Gasik deposits $5,000 and borrows $5,000 from Last National Bank to purchase a $10,000 six-month money market certificate. At maturity, the certificate will pay interest of $793, but Dr. Gasik will receive only $372 (the interest earned minus $421 of interest due on the $5,000 loan from Last National). Dr. Gasik must report $793 as interest income on his income tax return for the year in which the certificate matures. If Dr. Gasik itemizes deductions, he may include the $421 interest expense in the computation of his investment interest deduction. However, if he does not itemize, any deduction will be lost. Neither Dr. Gasik nor the bank may offset the interest expense against the interest income for purposes of income tax reporting requirements.
If a short-term (i.e., a term of one year or less) certificate of deposit is issued at a discount, any interest expense paid or incurred on amounts borrowed to purchase or carry such certificate is usually deductible only in the year the certificate matures (or is disposed of); however, if there is an election to include the original issue discount on the certificate in income as it accrues, the current deduction of the interest expense will be limited only by the investment interest limitation explained in Q 8040. See also Q 8045.