Reduce Taxes with this Overlooked Deduction?

A long, long time ago, the Internal Revenue Service allowed individuals to deduct all their interest charges, even credit-based card interest - but today, it is possible to solely deduct certain kinds of interest and cannot reduce taxes as was formerly achievable. Probably the most obvious deduction is home mortgage and home equity loan interest. However investment interest costs are also tax-deductible - and frequently overlooked as a means to reduce taxes.

Once you loan cash to purchase taxable investments - for example, when you buy stocks on margin - the interest you pay on that loan is called an investment interest expense. You can deduct this interest to the extent of your taxable investment income - that's, income from interest and short-term capital gains. In case your investment interest cost is much greater than your taxed investment income, the excess interest cost can be carried over to the next tax year. Which means you not just reduce taxes this yr but possibly in the future.

Additionally note that we mentioned interest on loans used to buy taxable investments is deductible. Interest on financial loans used to buy non-taxable investments, including municipal bonds or municipal bond resources, is not deductible.(However, when the loan proceeds aren't directly used to purchase tax free bonds but the proceeds free up other funds to purchase tax free investments, it becomes challenging to trace by IRS. Talking to your tax consultant to reduce taxes this way is recommended).

So why do we are saying your taxed investment income includes interest and short-term capital gains, although not mention additional obvious investment income, including certified dividends and long-term capital gains? This is where the laws gets tricky. In case you wish, you might treat all or part of your qualified returns and long-term capital gains as investment income. This, obviously, will allow you to potentially deduct much more of your investment-interest expense. The issue: The long-term capital gains and certified dividends will then be treated as investment income, and be taxed at your normal tax rate - which may be higher than the 15% tax rate for qualified dividends and long-term capital gains, based on your income tax bracket. Which means you likely have to see a tax advisor to help reduce taxes with this technique. It pays for some but not others.

Exactly what does this mean? If you have to borrow to purchase investments, it may be a good way to reduce taxes -- to make use of money to purchase the non-taxable investments, and used the loan proceeds to purchase the taxable investments.