Investment Interest Relief

PLR 201016032

This was originally published on PAOO on July 30th, 2010.

If you are someone who invests on margin PLR 201016032 might be of interest to you (pardon the unintentional pun). Back in the good old days interest used to be just deductible. Yeah they got upset if you used it to buy tax exempt bonds, but other than that it was cool. It hasn't been that way for quite a while. Interest expense falls in several different classes. In general which class the interest falls under is determined not by how the money was borrowed, but by what it was spent on. There are fairly mind numbing regulations, that tell you how you are supposed to trace borrowed money. If a residence is involved it can be important as to how the debt is secured.

Investment interest is deductible as an itemized deduction, but only to the extent of your investment income. If the interest exceeds investment income it is carried over to the next year. The carryover never expires. A problem, though, is that the definition of investment income does not include long term capital gains or qualified dividends. I will overcome my reticence on commenting on logic having anything to do with taxes to point out that capital gains and qualified dividends are taxed at a preferential rate. What if the only investment income you ever have is long term capital gain and qualified dividends ? You are allowed to elect to treat that income as investment income. The cost of the election is that you don't get the preferential treatment on the income you reclassify. The election has to be made on a timely filed return.

The taxpayer in the ruling managed to find a preparer who wasn't aware of the election. Neither was the taxpayer until contacted by the preparer - light having dawned on Marblehead - two years later. The Service allowed the taxpayers sixty days from the date of the ruling to amend their return and make the election.

If you invest on margin or otherwise have investment interest ( You may for example have received a debt financed distribution from a partnership which you deposited into your brokerage account), take a look and see if your return has Form 4952 attached. On Part III Line 7, there may be a number showing your carryover of investment interest. If that number is a NUMBER, you may want to discuss with your preparer whether you might benefit from the election in the future. If it is REALLY A NUMBER, it may be worth amending even if you have to request permission for a late amendment.