Is Investment Interest Expense an Itemized Deduction?

Yes, investment interest expense is an itemized deduction, but it is subject to limitations. This interest arises from debt used to purchase property held for investment, such as stocks, bonds, or raw land. The deduction’s size is directly tied to the net investment income a taxpayer earns during the year. To claim it, you must itemize deductions rather than taking the standard deduction and complete a specific calculation.

Qualifying Investment Interest and Income

Investment interest expense is the interest paid on money you borrow to purchase property held for investment. A common example is the interest charged on a margin loan from a brokerage account used to buy stocks. If you borrow money and use only a portion of it for investment purposes, you must allocate the interest paid; only the share of interest attributable to the investment is deductible. It is important to distinguish this from interest on personal loans, like car loans or credit card debt, which is not deductible as investment interest.

Other types of interest are also explicitly excluded. Interest expenses related to a passive activity, which is a business or rental activity in which you do not materially participate, are not considered investment interest. You also cannot deduct interest on loans used to purchase tax-exempt securities, such as municipal bonds, because the income from these investments is already free from federal tax. Interest connected to a trade or business you operate is handled under different rules.

Investment income forms the ceiling for your potential deduction. This category includes:

• Interest from savings accounts
• Non-qualified dividends
• Annuities
• Royalties not derived from a trade or business
• Net short-term capital gains from the sale of investment property

By default, long-term capital gains and qualified dividends are not included in the investment income calculation because they are taxed at lower rates. A taxpayer can elect to include this income to potentially increase their interest deduction, but this decision alters how that income is taxed.

The Deduction Limitation and Calculation

The rule governing this deduction is that your deductible investment interest expense cannot exceed your net investment income for the tax year. Net investment income is your gross income from property held for investment less any associated investment expenses, other than the interest itself. Through 2025, common investment-related costs like advisory fees are not deductible and therefore do not reduce your gross investment income for this calculation.

This limitation creates a direct link between the income your investments generate and the amount of interest expense you can deduct. For instance, if you paid $5,000 in margin loan interest but only had $3,000 of net investment income, your deduction for that year would be capped at $3,000. The purpose of this rule is to prevent taxpayers from using investment-related interest to offset other, non-investment sources of income, such as wages or business profits.

As mentioned, you can make a special election to include long-term capital gains and qualified dividends in your investment income. This choice can increase your net investment income, thereby raising the limit on your deductible interest expense. The consequence is that the amount of long-term gains and qualified dividends you include is no longer eligible for the lower capital gains tax rates and is instead taxed at your ordinary income tax rate.

This trade-off requires careful consideration. Assume you have $4,000 in investment interest expense and only $1,000 in ordinary investment income, but you also have $3,000 in qualified dividends. Without the election, your deduction is limited to $1,000. If you elect to treat the $3,000 of qualified dividends as investment income, your net investment income becomes $4,000, allowing you to deduct the full $4,000 of interest. However, that $3,000 is now taxed at your marginal ordinary income rate, which could be significantly higher than the 0%, 15%, or 20% long-term capital gains rates.

Reporting the Deduction and Managing Carryovers

To claim the deduction, you will need to enter specific financial information onto IRS Form 4952, Investment Interest Expense Deduction. This includes the total investment interest you paid, any interest carried over from a prior year, and your gross investment income figures. Broker statements like Form 1099-INT or 1099-DIV are common sources for this data.

Form 4952 guides you through the calculation to determine your net investment income, providing a specific line to make the election to include long-term capital gains and qualified dividends. The form ultimately determines your deductible amount for the year, which is the smaller of your total investment interest or your net investment income. The final deductible amount is then transferred to Schedule A (Itemized Deductions).

A feature of the investment interest expense rules is the carryover provision. If your total investment interest expense for the year is more than your net investment income, the disallowed portion is not permanently lost. Form 4952 automatically calculates this disallowed amount, which you can then carry forward to the following tax year. This carried-over interest is treated as if it were paid in that future year and can be deducted then, subject to that future year’s net investment income limitation. This process can continue indefinitely.