Is Margin Interest Tax Deductible?
- Margin accounts allow investors to borrow funds or securities from their brokers to use in trading activities -- it's a basic, flexible loan. As long as you use this loan for taxable investment activities, the interest you pay is qualified investment interest. The term taxable is key here. Margin loans for non-taxable municipal bonds would not qualify, but stock transactions would.
- Investment interest expenses offset your net taxable investment income. This is the value of your investment interest income, short term capital gains and ordinary dividends less any related expenses. Long-term capital gains and qualified dividends are given a preferential tax rate, currently no more than 20 percent. You can choose to include these items in your net taxable investment income if you like, since in some cases the offset will provide for a lower overall tax than the preferential rate.
- You cannot use more of your interest expense than you have taxable income -- you may offset your taxable income to zero, but not below that. If you have more interest expense than taxable income in a given year, you can carry the extra ahead to the next year. For example, if you have $1,000 in taxable interest expense and $400 in taxable income, you can use $400 of the interest expense for this year, and use the other $600 in the future.
- Some margin accounts allow investors to take out a cash loan. This may be beneficial to investors for any number of reasons, low interest rates and flexible repayment terms being two of the major ones. The interest on a cash loan is only deductible if you use that money to purchase an investment -- something you do not use for yourself. Rental property counts but a primary residence does not, even if you think you'll get more money out of the primary residence in the future than you paid for it. Exclude this type of margin interest from your calculations.
