Securities loan (aka margin loan) interest tax deductions | Investment interest expense deduction

Did you know that you can deduct interest that you're paying on your margin loan against income generated from your portfolio? This is through something called the investment interest expense deduction.

This is a valuable, yet slightly nuanced deduction. Watch this short video to learn how to maximize this deduction for you.

Transcript:

On today's video, we're going to be talking about securities loan interest tax deductions. Securities loans are commonly referred to as margin loans. And if you're paying interest on these loans, you might be able to deduct them on your tax return. I'm Chris Kaminski, co-founder and partner here with Consilio Wealth, where we specialize in working with tech professionals at Amazon, Microsoft, Meta, and Google.

Did you know that you can deduct interest that you're paying on your margin loan? This is through something called the investment interest expense deduction, and it allows you to take the interest that you're paying on your margin loan and put that against income that you're generating from your investments, things like dividends, short-term capital gains, to effectively erase them from your tax return and pay no taxes on them. Let's find out more. Real quick, what's a margin loan?

A margin loan is a loan on your investments. Typically, the loan available is 50% of your investment balance, although that varies depending on what's in your account, whether it's a concentrated stock or if your account's full of bonds or if your account's a diversified portfolio. But let's just run with 50% of your account balance can be loaned out. There are no questions asked when you take a loan like this. No credit reporting, no credit check. There's not even any required payments. Interest just adds right back to the loan and there's no specific payback period. We'll link to a video here so you can learn.

Okay, so margin interest can be deducted against investment income generated on non-retirement investment accounts. Investment income is things like non-qualified dividends, interest, and short-term capital gains. There is a cap on your deduction, however. You can only deduct up to the amount of interest, short-term capital gains, or net investment income, essentially, that you're generating on your investments. So, for example, let's say that you had $5,000 of margin interest that you paid, and you had $10,000 of investment income. You could take that $5,000 against the $10,000 of income and you would only pay tax on the $5,000 net. Let's say that you had $20,000 of margin interest and you had $10,000 of investment income. You would now pay no tax on that $10,000 of investment income and the remaining $10,000 of unused margin interest could be carried forward into a future tax year. Pretty cool.

Note that one of the things that you can buy with a margin loan is more securities. Buy more stocks, you can buy some bonds. If you do that and you buy municipal bonds, which generate tax, free income, you are not allowed to deduct the interest expense paid on that loan against tax-free income.

Again, see above short-term capital gains or generally investment income that's taxed at highest marginal tax brackets rather than long-term capital gains treatment. Okay, I want to touch on a point here. Technically, you can only use margin interest to deduct against short-term capital gains, non-qualified dividends, which are also taxed at short-term capital gains rates or interest income from things like bonds.

However, you're allowed to make a special election on your tax return that would make long-term capital gains and qualified dividends taxed at short-term capital gains rates. Why in the world would you do this? Because it would then allow that income to be deducted against the margin interest expense that you've incurred, which would make that income tax-free. Couple of other things to note, you must itemize on your tax return in order to take this deduction versus take the standard deduction. That's because the investment interest expense goes on your schedule A. And in addition to that, you'll need to file form 4952, and with everything like this, it's probably best to work with a well-qualified CPA or tax professional to help you file this on your tax return and make sure that it's done correctly. So, we'd recommend that you seek out some advice there if you don't already have it.

All right, hope that was helpful. One more arrow in your quiver.