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Investment Expenses: What's Tax Deductible?

Investment Expenses: What’s Tax Deductible?

Key Points
  • If you itemize your deductions, you may be able to deduct a number of investment-related expenses on your tax return.

  • If you borrowed money to purchase taxable investments you might be able to use the interest expenses from the loans to reduce your taxable investment income.

  • Up to $3,000 of capital losses can be used to offset ordinary taxable income.

If you itemize deductions on your annual tax returns, make sure you’re not missing out on deductions for investment expenses you paid. The IRS allows taxpayers various tax deductions for the investment-related expenses if that expense is related to producing taxable investment income.

Maximizing your tax deductions has the potential to reduce your tax burden, so let’s look at some of the most common deductible investment expenses and how they can reduce your taxable income.

Miscellaneous investment-related itemized deductions

You can deduct certain miscellaneous investment-related expenses from your taxable income once those expenses cross a certain threshold based on your income, which we’ll explain below. First, a list of those expenses, as well as some expenses that aren’t included.

Investment-related expenses that you may be able to deduct:

  • Fees for investment counsel and advice, including subscriptions to financial publications and research used to guide your investment decisions.
  • Software or online services used to manage your investments.
  • Charges for automatic investment services and dividend reinvestment plans.
  • Transportation to your broker’s or investment advisor’s office.
  • Safe deposit box rent (if the box is used to store certificates or investment-related documents).
  • IRA or Keogh custodial fees, if paid by cash outside the account.
  • Attorney, accounting or clerical costs necessary to produce or collect taxable income.
  • Costs to replace lost security certificates.

Investment related expenses that can’t be deducted:

  • Trading commissions: These expenses are added to the cost basis of your investment, also known as “capitalizing” the expense. When you eventually sell the investment these expenses will reduce your taxable gain on the sale.
  • Investment advisory fees related to tax-exempt income: The general rule is if the income is not taxable then the expenses related to that investment are not deductible. If you pay a single fee to your investment advisor it may be difficult to identify the fees related to your tax-exempt investments. In these situations it is generally best to deduct only the portion of the advisory fee related to your taxable investments.
  • Costs of traveling to attend a shareholder’s meetings.
  • Borrowing costs associated with life insurance.

You can’t claim a deduction for miscellaneous investment-related expenses unless they amount to 2% or more of your adjusted gross income (AGI). Put another way: Imagine putting all your investment expenses into a bucket. Once the bucket is full (this is the 2% limitation), the expenses that overflow from the bucket are what you are allowed to deduct on your return.

Let’s consider an example. Mary has $100,000 of AGI and $5,000 in investment related expenses. The table below shows how she would calculate her deduction.

Example #1
Calculation of deductible investment expenses
Step 1  
Adjusted gross income (AGI) $100,000
Multiplied by the 2% AGI limit 2%
Equals the cap on deductible investment expenses $2,000
   
Step 2  
Total investment expense for 2017 $5,000
Minus disallowed investment expenses $2,000
Equals deductible investment expenses $3,000
   
Change in Mary’s Taxable Income  
Total taxable income (AGI) $100,000
Minus deductible investment expenses $3,000
Taxable income (after investment expenses) $97,000

Again, the first $2,000 isn’t deductible. However, Mary does get to deduct the remaining $3,000 as an itemized deduction on Schedule-A of her Form 1040, thereby reducing her taxable income from $100,000 to $97,000.

Investment interest expense

Investment interest expense is the interest paid on money borrowed to purchase taxable investments. This would cover margin loans you use to buy stock in your brokerage account. In such cases, you can deduct the interest on the margin loan. (This wouldn’t apply if you used the loan to buy tax-advantaged investments such as municipal bonds.)

The amount that can be deducted in a given year is capped at your net taxable investment income for the year. Any leftover interest expense gets carried forward to the next year and potentially can be used to reduce taxes in the future.

To calculate your deductible investment interest expense, you need to know the following:

  • Your total investment income for investments taxed at your ordinary income rate. This normally includes ordinary dividends and interest income, but does not include investment income taxed at the lower capital gains tax rates, like qualified dividends or municipal bond interest which is not taxed.
  • Your deductible investment expenses (the amount we calculated in Example #1)
  • Your total investment interest expenses (for loans used to purchase taxable investments).

To calculate your deductible investment interest expense, you first need to determine net investment income by subtracting your deductible investment expenses from your total investment income. Then compare your net investment income to your investment interest expenses. If your expenses are less than your net investment income, the entire investment interest expense is deductible. If the interest expenses are more than the net investment income, you can deduct the expenses up the net investment income amount. The rest of the expenses are carried forward to next year.

Let’s say Mary has $11,000 of investment income (from ordinary dividends and interest income), $3,000 of deductible investment expenses and $10,500 of investment interest expenses from a margin loan.

Example #2
Calculation of deductible investment interest expenses
Step 1    
Investment income (taxed at the ordinary income rate)   $11,000
Minus deductible investment expenses   $3,000
Equals net investment income   $8,000
     
Step 2    

The allowable deduction is the smaller of:

  • net investment income or
  • investment interest expenses

Deductible investment interest expenses




$8,000

$10,500






$8,000
     
Leftover investment interest expenses of
(carried forward to next tax year)
$2,500  
     
Change in Mary’s taxable income    
Taxable income (from Example #1)   $97,000
Minus the deductible investment interest expenses   $8,000
Taxable income (after investment interest expenses)  

$89,000

Because of the investment interest expense deduction, Mary’s taxable income has been reduced even further, from $97,000 to $89,000.

How do qualified dividends affect investment interest expense deduction calculations?

Qualified dividends that receive preferential tax treatment aren’t considered investment income for purposes of the investment interest expense deduction. However, you can opt to have your qualified dividends treated as ordinary income.

In the right circumstances, electing to treat qualified dividends as ordinary dividends can increases your investment interest expenses deduction, which allows you to pay 0% tax on the dividends instead of the 15% or 20% tax qualified dividends normally receive.

Here’s an example of how it might work.

Mary has $2,000 of qualified dividends in 2017, on which she would normally pay $300 in tax ($2,000 x 15% tax rate). If Mary elected to treat the qualified dividends as ordinary income she could boost her net investment income from $8,000 to $10,000. As a result, she would be able to deduct more of her investment interest expense in the current year—and pay no tax on the qualified dividends.

Example #3
Calculation of deductible investment interest expenses if qualified dividends are treated as ordinary income
Step 1    
Investment income (from Example #2)   $11,000
Plus qualified divided income   $2,000
Equals total investment income   $13,000
Minus deductible investment expenses (from Example #1)   $3,000
Equals net investment income   $10,000
     
Step 2    

The allowable deduction is the smaller of:

  • net investment income or
  • investment interest expenses

Deductible investment-interest expenses

 


$10,000

$10,500






$10,000
     
Leftover investment interest expenses
(carried forward to next tax year)
$500  
     
Change in Mary’s taxable income    
Taxable income (from Example #1)   $97,000
Minus deductible investment interest expenses   $10,000
Final taxable income   $87,000

Because Mary is a tax-savvy investor, she was able to reduce her taxable income from the original $100,000 to $87,000.  That’s a $13,000 reduction in taxable income, which could result in $3,250 of tax savings if her marginal tax rate is 25%.

Note: The election to treat qualified dividends as ordinary dividends should not be taken lightly. Once made, the election can only be revoked with IRS consent. Consult with your tax professional before implementing this tax strategy.

Capital losses

Losing money is never fun, but luckily there is a silver lining. Capital losses can be used to offset your capital gains. If your capital losses exceed your capital gains, up to $3,000 of those losses (or $1,500 each for married filing separately) can be used to offset ordinary income and lower your tax bill. Net losses of more than $3,000 can be carried forward to offset gains in future tax years.

For more information about maximizing the tax benefit of capital losses and tax strategies like tax loss harvesting, see “Reap the Benefits of Tax-Loss Harvesting to Lower Your Tax Bill.”

Don’t forget about the cost basis of your investment

To make the most effective use of capital losses, keep track of your investments cost basis. The cost basis is generally equal to an investment’s purchase price plus any expenses necessary to acquire that asset, such as commissions and transaction fees. Later, when you sell your investment the cost basis is used to reduce the taxable gain. For more on cost basis, see “Save on Taxes: Know Your Cost Basis.”

What to do now

The IRS also has some resources that provide examples and detailed explanations of the topics included in this article, including: Publication 550, Publication 529, and the instructions for Form 1040, Schedule A, Schedule D, and Form 4952.

In addition, be sure to consult your tax professional (CPA, lawyer, or enrolled agent) about your situation, preferably well before the end of the year.  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.

What you can do next

Important Disclosures

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.

Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

The type of securities and accounts mentioned may not be suitable for everyone. Each investor needs to review a security transaction for his or her own particular situation.

This information does not constitute and is not intended to be a substitute for specific individualized tax, legal, or investment planning advice. Where specific advice is necessary or appropriate, Schwab recommends consultation with a qualified tax advisor, CPA, financial planner, or investment manager.

The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.

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