8705 / Can a taxpayer deduct interest expenses incurred in relation to property the taxpayer holds for investment?
Yes, within limits. Because of the substantial tax benefits that can result when a taxpayer’s interest expenses are large compared to the amount of income realized from the investments at issue, Congress has taken steps to limit the amount of investment interest that a taxpayer can deduct in any tax year.
Therefore, a noncorporate taxpayer is permitted to deduct interest expenses incurred in funding the purchase of investment assets, but only to the extent that the taxpayer’s interest expenses exceed net investment income (see below) for the year.1 Any other investment interest expense is considered excess interest and is disallowed.
“Net investment income” for purposes of the interest expense deduction means the excess of investment income over investment expenses.2 “Investment income” means the sum of the following four items:
(1) Gross income derived from property held for investment other than gain derived from the disposition of that property (e.g., income from interest, dividends, annuities and royalties not derived in the ordinary course of the taxpayer’s trade or business);