2018 Tax Law Changes
Investment expenses are no longer tax deductible. Read “New 2018 Tax Law (Tax Cuts and Jobs Act)” for more information.
Many types of investment expenses are tax-deductible as itemized deductions. The most common is fees paid to professional investment managers for services rendered on taxable accounts. But is the same true of margin expenses?
Since margin expenses do occur in investing (although we highly recommend that you avoid being on margin in the first place), we would expect that they would be deductible.
And they are, but the amount you can deduct is limited. Going on margin is, essentially, getting a very short-term loan. What is often called “margin expenses” is the repayment of interest on the loan. As a result, the IRS treats margin expenses like any other investment interest paid. That means you can only deduct up to your net investment income.
Form 4952 is how you figure out how much investment interest you can deduct. The general formula is that you can deduct either Margin Expenses or (Investment Income – Investment Expenses) whichever is smaller.
For these purposes, investment income includes interest you earned, annuity payments, royalties you earned, and ordinary dividends. You have the option of including capital gains and qualified dividends in this list. That might seem like a good idea as boosting your investment income gives you a greater chance of deducting all your margin expenses, but that decision also would invalidate the more valuable tax-favored status of those gains and dividends. That total income is offset by all investment expenses, including management fees.
Since annuities don’t deserve a place in your portfolio, they won’t give you any help towards deducting margin expenses. Few people have investments that earn them royalties. For most people, that means interest expenses and ordinary dividends alone have to exceed management fees and other expenses before margin expenses can be deducted.
Two final rules apply. Margin expenses can only be deducted if they were incurred for the purchase of taxable investments. Although the exact calculations are complex, this basically rules out the ability to deduct margin expenses when buying municipal bonds or from margin in a non-taxable account. Lastly, the margin interest must have been actually paid by December 31 to count, not just accrued.
All of these factors make deducting margin expenses technically possible, but practically unlikely. When you consider that it is generally not a good idea to go on margin in the first place, you shouldn’t have a lot of expenses to deduct.
The ability to deduct margin expenses is a tax tool available to investors. Use it if you need to, but know that it will likely be of limited utility.
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