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Investment expenses - Investment expenses include all income-producing expenses (other than interest expense) relating to investment property that are allowable deductions after applying the 2% limit that applies to miscellaneous itemized deductions. Use the smaller of:

• The investment expenses included on Schedule A (Form 1040), line 22, or

• The amount on Schedule A, line 26.

Losses from passive activities - Income or expenses that you used in computing income or loss from a passive activity are not included in determining your investment income or investment expenses (including investment interest expense). See IRS Publication 925 for information about passive activities.

Example.
Ted is a partner in a partnership that operates a business. However, he does not materially participate in the partnership's business. Ted's interest in the partnership is considered a passive activity.

Ted's investment income from interest and dividends (other than qualified dividends) is $10,000. His investment expenses (other than interest) are $3,200 after taking into account the 2% limit on miscellaneous itemized deductions. His investment interest expense is $8,000. Ted also has income from the partnership of $2,000.

Ted figures his net investment income and the limit on his investment interest expense deduction in the following way:

1. Total investment income $10,000
2. Minus: Investment expenses (other than interest) 3,200
3. Net investment income $6,800
4. Deductible investment interest expense for the year $6,800

The $2,000 of income from the passive activity is not used in determining Ted's net investment income. His investment interest deduction for the year is limited to $6,800, the amount of his net investment income.

Back to: Investment Interest Expense Index

Other sections to read about investment interest expense: Investment Interest Expense, Investment Interest General Information, Allocation of Interest Expense, When to Deduct Interest Expense, Form 4954 Guidelines, Investment Income of Children, Limits on Investment Interest Deduction, Investment Expenses