IRS Form 4952: Investment Interest Expense Deduction

Taxpayers can deduct the interest paid on funds borrowed for investments by filing IRS Form 4952, Investment Interest Expense Deduction. Investment interest is the interest paid on a loan used to purchase property held for investment, such as stocks, bonds, or land. The form is used to calculate how much investment interest you can deduct in the current year and any amount to be carried forward. The deduction is limited by the amount of income your investments generate during the year.

Determining Who Must File

An individual, estate, or trust that has investment interest expense must file Form 4952 to claim a deduction. If you have no investment interest expense, there is no need to file this form.

A specific exception allows certain taxpayers to avoid filing Form 4952. You are not required to file the form if your investment interest expense is less than your investment income from interest and ordinary dividends, you have no other deductible investment expenses, and you do not have any disallowed interest carried over from a previous tax year. This exception allows for a direct deduction on Schedule A without the detailed calculation.

Information Required to Complete the Form

The first component needed is your total investment interest expense for Part I of the form. This is interest from money borrowed to purchase or carry property held for investment. A common example is margin interest paid on a loan from your brokerage account to buy stocks or bonds, which is reported on Form 1099-INT or a consolidated brokerage statement. It is important to distinguish this from other types of interest, such as personal loan interest or qualified home mortgage interest, which are not deductible as investment interest.

Next, you will need to tally your gross investment income for Part II. This includes income like interest received (reported on Form 1099-INT), non-qualified dividends (from Form 1099-DIV), and royalties not derived in the ordinary course of a trade or business. Income passed through from partnerships or S corporations on a Schedule K-1 is also included. Notably, qualified dividends and net capital gains are not automatically included as investment income because they receive preferential tax treatment.

Finally, you must identify other investment expenses. These are costs, other than the interest itself, incurred to produce investment income. For tax years 2018 through 2025, most miscellaneous itemized deductions have been suspended, which limits the types of expenses that can be included here.

Calculating the Allowable Deduction

The calculation on Form 4952 is based on a primary limitation: your investment interest expense deduction cannot exceed your net investment income. Net investment income is your gross investment income minus any other deductible investment expenses. For example, if you paid $4,000 in margin interest but only had $2,500 of net investment income, your deduction would be limited to $2,500.

You can elect to include some or all of your net capital gains and qualified dividends in your investment income calculation. Making this election increases your net investment income, which can increase the amount of investment interest you are allowed to deduct in the current year.

This choice involves a trade-off. By including these capital gains and qualified dividends as investment income, you forfeit the lower tax rates that normally apply to them. That income will instead be taxed at your higher, ordinary income tax rate.

For example, if you have $5,000 of investment interest and only $3,000 of ordinary investment income, you could elect to include $2,000 of qualified dividends in your investment income. This would allow you to deduct the full $5,000 of interest, but the $2,000 of dividends would be taxed as ordinary income.

Handling Disallowed Interest and Carryforwards

When your total investment interest expense exceeds your net investment income, a portion of your interest is disallowed as a deduction for the current year. This disallowed amount is not permanently lost, as the tax rules permit you to carry this excess interest forward to the next tax year.

The amount of disallowed interest is calculated in Part III of Form 4952 and represents the difference between your total investment interest paid and your allowable deduction. This carryforward amount is treated as investment interest paid in the following year.

In the subsequent tax year, this carried-over interest is combined with any new investment interest you pay, and the total is subject to the deduction limit based on that future year’s net investment income. This process can continue until the interest is fully deducted.

Filing the Form with Your Tax Return

Once completed, Form 4952 must be filed with your annual income tax return, Form 1040. The final deduction amount from line 8 of Form 4952 is transferred to the line for investment interest on Schedule A (Form 1040).

If filing a paper return, the completed Form 4952 is attached to your Form 1040. For those using tax preparation software to e-file, the program will use your entered information to populate Form 4952.

The software then automatically carries the final deduction to Schedule A and includes the form as part of the electronic submission to the IRS.