8042 / How is the investment interest deduction coordinated with the passive loss rules?

The investment interest limitation is coordinated with the passive loss rules (see Q 8010 to Q 8021), so that interest and income subject to the passive loss rules are not taken into consideration under the investment interest limitation.¹ Interest expense incurred to purchase an interest in a passive activity is allocated to that passive activity and is not investment interest.² (Very generally, a passive activity is any activity that involves the conduct of a trade or business in which the taxpayer does not materially participate and any rental activity.)³ However, portfolio income of a passive activity and expense (including interest expense) allocable to it is considered investment income and expense, not passive income and expense.⁴

Temporary regulations provide that, for purposes of the investment interest and passive loss rules, interest expense is generally allocated on the basis of the use of the proceeds of the underlying debt (see Q 8043).

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1.  IRC §§ 163(d), 469.

2.  Temp. Treas. Reg. § 1.163-8T(a)(4)(B).

3.  IRC § 469.