Is Margin Loan Interest Tax Deductible?
- Brokerage firms often allow their customers to borrow money to buy securities, using the value of those securities as collateral. For example, an individual with a $10,000 account may buy $17,000 worth of stock in a company, taking a $7,000 margin loan in the process. Investors will typically want to deduct interest payments associated with such loans from their personal income taxes in the same manner that other business expenses may be deducted.
- Margin interest payments can indeed be treated as deductible expenses, provided they are deducted only to the extent of investment income. Determining what qualifies as investment income can be tricky, but common allowable categories of such income include taxable stock dividends, taxable interest income, and short-term capital gains. If an individual makes margin interest payments that exceed her investment income, the excess amount can be carried forward and used to offset investment income in future years.
- Because individual taxpayers typically use the cash accounting method rather than the accrual accounting method, margin interest can usually only be deducted to the extent that it is actually paid in the year that the deduction would be made. For example, an individual who takes a margin interest loan in a particular year, but never makes a payment on the loan during that year, will not be able to take the deduction: this can easily occur as brokerages may require a margin loan to be paid only when a security is eventually sold. Even if interest payments are made monthly, December payments may not be made until the following year.
- The tax laws only allow margin interest to be deducted when the associated loan is made to support the purchase of taxable investments. If a margin loan is used to purchase an investment that produces non-taxable income, then the interest payments on that loan cannot be deducted on the taxpayer's return in any year. For example, if an individual buys a municipal bond that is exempt from federal income tax, she cannot claim a federal income tax deduction for a margin loan used to buy the bond.
