547. Is interest deductible?Nuco Employeercline202014-07-25T18:52:00Z2014-07-25T18:52:00Z49665511UMKC4512646514Site Map/General Income Taxation/Individuals/Deductions/Itemized/Interest/Generallydeduction2005-01-25T00:00:00ZTaxFactsDefaultArticleSite Map/General Income Taxation/Quick Clicks/Itemized Deductions119130823-00-tf1.xml823.00;#1736;#1748;#0x010100C568DB52D9D0A14D9B2FDCC96666E9F2007948130EC3DB064584E219954237AF3900242457EFB8B24247815D688C526CD44D009C4E67E972694125ABDA91AC61F5E51FTax Facts 1Is interest deductible?138000.000000000TaxFactsDefaultArticleSBMEDIA\moss-admin2010-01-15T01:13:26Z4111dbb3-6119-41fc-9d9c-28768801cec4|6a522468-4806-4f66-b270-fa03c90d2721|3bace7bb-4c21-47ad-b81b-9fba4568d813547. Is interest deductible?The deductibility of interest depends on its classification, as described below. Furthermore, interest expense that is deductible under the rules below may be subject to the additional limitation on itemized deductions (unless it is investment interest, which is not subject to that provision). Interest must be classified and is deductible within the following limitations:(1)Investment interest. This includes any interest expense on indebtedness properly allocable to property held for investment.IRC Sec. 163(d)(3). Generally, investment interest is deductible only to the extent of investment income; however, investment interest in excess of investment income may be carried over to succeeding tax years. For purposes of this calculation, net long-term capital gain income is included in investment income if the taxpayer foregoes the reduced tax rate (0%/15%/20%) that applies to such income. Under JGTRRA 2003, as extended by ATRA, certain dividends are taxable at the lower capital gains rates rather than at higher ordinary income tax rates. A dividend will be treated as investment income for purposes of determining the amount of deductible investment interest income only if the taxpayer elects to treat the dividend as not being eligible for the reduced rates.IRC Secs. 1(h)(11)(D)(i), as amended by ATRA, 163(d)(4)(B). For the temporary regulations relating to an election that may be made by noncorporate taxpayers to treat qualified dividend income as investment income for purposes of calculating the deduction for investment interest, see Treas. Reg. §1.163(d)-1.69 Fed. Reg. 47364 (8-5-2004). See also, 70 Fed. Reg. 13100 (3-18-2005).(2)Trade or business interest. This includes any interest incurred in the conduct of a trade or business. Generally, such interest is deductible as a business expense.IRC Sec. 162.(3)Qualified residence interest. Qualified residence interest is interest paid or accrued during the taxable year on debt that is secured by the taxpayer’s qualified residence and that is either (a) “acquisition indebtedness” (that is, debt incurred to acquire, construct or substantially improve the qualified residence, or any refinancing of such debt), or (b) “home equity indebtedness” (any other indebtedness secured by the qualified residence). There is a limitation of $1,000,000 on the aggregate amount of debt that may be treated as acquisition indebtedness, but the amount of refinanced debt that may be treated as acquisition indebtedness is limited to the amount of debt being refinanced. The aggregate amount that may be treated as “home equity indebtedness” (that is, borrowing against the fair market value of the home less the acquisition indebtedness, or refinancing to borrow against the “equity” in the home) is $100,000.IRC Sec. 163(h)(3). Indebtedness incurred on or before October 13, 1987 (and limited refinancing of it) that is secured by a qualified residence is considered acquisition indebtedness. This pre-October 14, 1987 indebtedness is not subject to the $1,000,000 aggregate limit, but is included in the aggregate limit as it applies to indebtedness incurred after October 13, 1987.IRC Sec. 163(h)(3)(D). (For 2007 through 2013, certain mortgage insurance premiums are treated as qualified residence interest).IRC Sec. 163(h)(3)(E), as amended by ATRA.A “qualified residence” is the taxpayer’s principal residence and one other residence that the taxpayer (a) used during the year for personal purposes more than 14 days or, if greater, more than 10% of the number of days it was rented at a fair rental value, or (b) used as a residence but did not rent during the year.IRC Sec. 163(h)(4)(A). See, e.g., FSA 200137033.Subject to the above limitations, qualified residence interest is deductible. If indebtedness used to purchase a residence is secured by property other than the residence, the interest incurred on it is not residential interest but is personal interest.Let. Ruls. 8743063 and 8742025. The Tax Court denied a deduction for mortgage interest to individuals renting a home under a lease with an option to purchase the property. Although the house was their principal residence, they did not have legal or equitable title to the home and the earnest money did not provide ownership status.Blanche v. Comm., TC Memo 2001-63, aff’d without opinion, 2002 U.S. App. LEXIS 6379 (5th Cir. 2002). An individual member of a homeowner’s association was denied a deduction for interest paid by the association on a common building because the member was not the party primarily responsible for repaying the loan and the member’s principal residence was not the specific security for the loan.Let. Rul 200029018. Assuming that the loan was otherwise a bona fide debt, a taxpayer could deduct interest paid on a mortgage loan from his qualified plan, even though the amount by which the loan exceeded the $50,000 limit of IRC Section 72(p) was deemed to be a taxable distribution.FSA 200047022.(4)Interest taken into account in computing income or loss from a passive activity. A passive activity is generally an activity that involves the conduct of a trade or business but in which the taxpayer does not materially participate, or any rental activity.IRC Secs. 163(d), 469(c).(5)Interest on extended payments of estate tax. Generally, this interest is deductible. (6)Interest on education loans. An above-the-line deduction is available to certain taxpayers for interest paid on a “qualified education loan.”IRC Secs. 163(h)(2)(F), 221. The deduction is subject to a limitation of $2,500 in 2014. The deduction is phased out for 2014, ratably for taxpayers with modified AGI between $65,000 and $80,000 ($130,000 and $160,000 for joint returns).IRC Sec. 221(b); Rev. Proc. 2013-35, 2013-47 IRB 537. Certain other requirements must be met for the deduction to be available.See IRC Sec. 221; Treas. Reg. §1.221-1.(7)Personal interest. This is any interest expense not described in (1) through (6) above and is often referred to as “consumer” interest.IRC Sec. 163(h)(2). Personal interest includes interest on indebtedness properly allocable to the purchase of consumer items and interest on tax deficiencies. Personal interest is not deductible.IRC Sec. 163(h)(1).The proper allocation of interest generally depends on the use to which the loan proceeds are put, except in the case of qualified residence interest. Detailed rules for classifying interest by tracing the use of loan proceeds are contained in temporary regulations.See Temp. Treas. Reg. §1.163-8T. The interest allocation rules apply to interest expense that would otherwise be deductible.Temp. Treas. Reg. §1.163-8T(m)(2).Various provisions in the Code may prohibit or delay the deduction of certain types of interest expense. For example, no deduction is allowed for interest paid on a loan used to buy or carry tax-exempt securities or, under certain conditions, for interest on a loan used to purchase or carry a life insurance or annuity contract (see Q 3).