Question

Edward is single with income that places him in the 35 percent marginal tax bracket for ordinary income and 15 percent for long-term capital gains. He incurs interest expense of $10,000 attributable to his investment in stocks and bonds. His gross investment income is $6,200 ($1,000 of which is from long-term capital gains and dividends) in 2019. He also has $20,000 of deductible home mortgage interest expense.

1. What are Edward’s options in determining his itemized deduction for investment interest expense? Explain.
2. What happens if he cannot deduct all $10,000 of the investment interest expense in the current year?

Answer 1

Edward can deduct $6,200 if he opts to forgo the maximum 15% for his capital gain and dividend income, otherwise he can only deduct $5,200($6,200 - $1,000).

Option 1 - If Edward opts to forgo the maximum 15% for his capital gain and dividend income

The allowable deduction is the smaller of these:

Net Investment Income $6,200

or, Investment interest expenses $10,000

Deductibe investment interest expenses = $6,200

Leftover interest expenses of $3,800($10,000 - $6,200) will be carried forward to next tax year.

Edward's itemized deduction for investment interest expense is $6,200 & for home mortgae interest expense is $20,000.

Option 2 If Edward do not opts to forgo the maximum 15% for his capital gain and dividend income

The allowable deduction is the smaller of these:

Net Investment Income $5,200

or, Investment interest expenses $10,000

Deductibe investment interest expenses = $5,200

Leftover interest expenses of $4,800($10,000 - $5,200) will be carried forward to next tax year.

Edward's itemized deduction for investment interest expense is $5,200 & for home mortgae interest expense is $20,000.