Tax-deductible investment expenses.
Certain investment expenses incurred on your taxable investments are tax-deductible. Understanding how to take full advantage of these deductions can help minimize the amount you pay in taxes.
The IRS lets you deduct certain investment expenses incurred on your taxable investments. Check with your tax professional to make sure you’re taking full advantage of miscellaneous investment-related itemized deductions, investment interest expenses, and capital losses.
Miscellaneous investment-related itemized deductions.
Miscellaneous itemized deductions are generally limited to the amount of expenses over and above 2% of your adjusted gross income (AGI). In other words, there’s a floor below which you lose the ability to deduct.
Here’s a list of investment-related expenses that you may be able to deduct:
- IRA or Keogh custodial fees (if paid by cash outside the account)
- Loss on traditional IRAs or Roth IRAs, when all amounts have been distributed to you
- Fees for investment counsel and advice, including subscriptions to financial publications
- Transportation to your broker’s or investment advisor’s office
- Attorney, accounting, or clerical costs necessary to produce or collect taxable income
- Tax advice fees (and tax-preparation fees)
- Charges for automatic investment services and dividend reinvestment plans
- Software or online services used to manage your investments
- Depreciation on home computers used for investments
- Rental fees for a safety deposit box (if used to store certificates or investment-related documents)
- Costs to replace lost security certificates
Investment-related expenses that can’t be deducted include:
- Trading commissions—these are “capitalized” to increase your cost basis and/or reduce your taxable sales proceeds
- Costs of traveling to attend a shareholder’s meeting
- Investment advisory fees related to tax-exempt income—you generally need to prorate these fees based on the portion of tax-exempt investment income versus total taxable investment income
- Borrowing costs associated with life insurance and life insurance premiums paid by the insured
Investment interest expense.
Investment interest expense is the interest on money you borrow to purchase taxable investments. For example, you can deduct the interest on a margin loan you use to purchase stock, but not if you use the margin loan to buy a car or tax-exempt municipal bonds.
There’s a cap on deductibility equal to your net investment income, but any leftover interest expense can be carried over for future use, without expiration.
To calculate your net investment income—and therefore how much investment interest expense you can deduct—add up your taxable interest income, ordinary dividends, and even long-term capital gains and qualified dividends (if you make a special election to treat them as ordinary income, more below). Then, subtract any miscellaneous investment-related itemized deductions you actually get to use.
How do the qualified dividend rules impact investment interest expense?
Qualified dividends that receive preferential tax treatment aren’t considered investment income for purposes of the investment interest expense deduction.¹ However, you could elect to treat qualified dividends as ordinary income (just as you can with net long-term capital gain income) to boost the amount you can deduct as investment interest expense. The concept here is that it’s better to pay 0% tax on qualified dividends than 15% or 20% tax.
Let’s go back to the example: If you also have $1,000 of qualified dividends, you could pay 15% (or 20%) tax on them, or you could elect to treat those dividends as ordinary income and boost your net investment income from $9,000 to $10,000—which means you could now deduct up to $10,000 in investment interest expense in the current year.
Payment in lieu of dividends.
If you buy dividend-paying stock on margin and your broker lends out the stock, you don’t really receive dividends, you receive payment in lieu of dividends. These payments are treated as ordinary income and aren’t eligible for the qualified dividend rate. But all is not lost: The payments are eligible to offset your investment interest expense.
However, if you already have sufficient ordinary investment income from other sources (or more payment in lieu of dividends than can be used), you’re stuck with ordinary tax treatment.
Capital losses can be used to offset capital gains without limit in any given year. If your capital losses exceed your capital gains, up to $3,000 in losses (or $1,500 each for married persons filing separately) could be used to offset ordinary income. Net losses of more than $3,000 can be carried forward to offset gains in the future without expiration during your lifetime.
1. Long-term capital gains and qualified dividends are currently taxed at a rate of 0% for income in the 15% federal marginal tax bracket or lower, 15% for brackets above that level up to the top bracket, and 20% for income that falls in the highest bracket. An additional 3.8% investment income surtax may also apply to taxpayers in higher tax brackets.
Reminder on cost basis reporting rules.
For more information on investment expenses, how to report all kinds of investment income (including mutual funds), and the rules for netting short-term and long-term capital gains, see IRS Publication 550: Investment Income and Expenses.
Be sure to consult your tax professional about your unique situation, preferably well before the end of the year. And no matter the time of year, it’s also a good idea to check with your tax advisor before you enter into any transaction that might have significant tax consequences.
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Where specific advice is necessary or appropriate, Schwab recommends consultation with a qualified tax advisor, CPA, financial planner or investment manager. Schwab does not provide legal or tax advice.
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