8613. Can a taxpayer deduct interest expenses incurred in relation to property the taxpayer holds for investment?cjumprcline202014-07-07T22:12:00Z2014-07-07T22:12:00Z25493131National Underwriter2673673148613. Can a taxpayer deduct interest expenses incurred in relation to property the taxpayer holds for investment?Yes, within limits. Because of the substantial tax benefits that can result when a taxpayer’s interest expenses are large compared to the amount of income realized from the investments at issue, Congress has taken steps to limit the amount of investment interest that a taxpayer can deduct in any tax year. Therefore, a noncorporate taxpayer is permitted to deduct interest expenses incurred in funding the purchase of investment assets, but only to the extent that the taxpayer’s interest expenses exceed net investment income (see below) for the year..IRC Sec. 163(d). Any other investment interest expense is considered excess interest and is disallowed. “Net investment income” for purposes of the interest expense deduction means the excess of investment income over investment expenses..IRC Sec. 163(d)(4)(A). “Investment income” means the sum of the following four items:(1)Gross income derived from property held for investment other than gain derived from the disposition of that property (e.g., income from interest, dividends, annuities and royalties not derived in the ordinary course of the taxpayer’s trade or business);(2)The excess, if any, of (i) “net gain” attributable to the disposition of property held for investment over (ii) the “net capital gain” determined by taking into account gains and losses from dispositions of property held for investment;(3)The taxpayer’s net capital gain determined by only taking into account gains and losses derived from the disposition of investment property or the taxpayer’s net gain attributable to disposition of property held for investment, whichever is lower, but only to the extent the taxpayer elects to treat such income as investment income for purposes of Section 163; and (4)Qualified dividend income, to the extent the taxpayer elects to treat such income as investment income for purposes of Section 163..IRC Sec. 163(d)(4)(B).In other words, net investment income, for purposes of the interest expense deduction, generally does not include net capital gain from the disposition of investment property unless the taxpayer makes the election to do so (see Q 8615 for the tax consequences of this election).The term “investment expenses” means deductions (other than the interest deduction) that are directly connected with the production of investment income..IRC Sec. 163(d)(4)(C). The Tax Court has held that net gain for purposes of IRC Section 163(d)(4)(B)(ii) means the excess (if any) of total gains over total losses, including capital loss carryovers, from the disposition of property held for investment. The Court further held that calculation of net gain required inclusion of the taxpayers’ capital losses and capital loss carryovers for purposes of calculating the IRC Section 163(d)(1) limit on the investment interest expense deduction.. Gorkes v. Commissioner, TC Summ. Op. 2003-160. The IRS has ruled privately that: (1)The term “property” (under IRC Section 163(d)(5)(A)(i)) includes interest-free loans (which are deemed to yield gross income as a result of interest imputed under IRC Section 7872) to a tax-exempt foundation; (2)Any imputed interest income that is deemed to be received by the taxpayer on the potential loan from the line of credit to the foundation is “investment income” (under IRC Section 163(d)(4)(B)(i)); and (3)Any interest paid by the taxpayer on the line of credit used to make the potential loan to the foundation is “investment interest” (under IRC Section 163(d)(3)(A))..Let. Rul. 200503004.See Q 8614 for a discussion of the treatment of disallowed interest expenses and Q 8616 for a discussion of how the interest expense deduction is impacted by the passive loss rules.