Deducting Interest on Investments
QUESTION: I understand that consumer interest other than mortgage interest--is being phased out under the new tax law, but that interest for investment purposes will still be deductible up to certain limits. But what about interest that could be interpreted as either consumer or investment interest? Say I have a credit card that allows the writing of checks against the credit line and I write one to buy stock and then pay off the accumulating interest over several months. Is this classified as consumer interest or investment interest?--H. S.
ANSWER: You have put your finger on one of the great puzzles emerging from the new tax laws.
Until this year, it made no difference for tax purposes whether a taxpayer’s non-mortgage interest expenses stemmed from investments or from consumer purchases. (Mortgage interest on principal and secondary residences remains fully deductible and therefore isn’t pertinent to this discussion). As long as the interest wasn’t generated from a loan used to buy tax-exempt investments, the whole lot was deductible from the taxpayer’s taxable income. No more.
Now, interest paid on school loans, credit cards and other so-called “consumer” items is being phased out as a tax deduction. But interest on investments remains deductible to the extent that the taxpayer has earned income from the investment. In other words, you can deduct $100 in interest expenses related to investments if you earned $100 from investments.
So, tax preparers are being inundated with questions like yours. Their answer: You have to trace how the loan--in your case, the credit card “advance”--was used from the time it was taken out until it was repaid.
Hence, if you used your credit card--normally considered a source of consumer interest--to buy stocks or other investments and let interest accumulate before you paid off the bill, the interest would be classified as investment interest.
By the same token, if you borrow money and use the loan to buy both stocks and a car, interest on the portion that went toward the stock purchases would be deductible to the extent that your investments generate income, while interest on the car-purchase portion would be 35% disallowed this year under the five-year phase out of consumer interest deductions.
As usual, there are some exceptions. Most important among them is the 15-day rule. If the loan proceeds aren’t spent within 15 days, the IRS will base the deduction eligibility on the first item to be purchased with the loan money.
Say the taxpayer borrowed $5,000 and added that amount to an account containing $1,000 of unborrowed money. He then waited more than 15 days before spending $4,000 on a car and $2,000 on stocks. The IRS would count $4,000 of the $5,000 loan as consumer interest and only $1,000 as investment interest.
Q: I know my timing is terrible, given tax reform, but I’m trying to make an argument for taking a tax deduction for my home office. If I can persuade my boss to have the company lease part of my home for business purposes, isn’t that adequate proof for the IRS that I really do have a home office worthy of a tax deduction?--S. B.
A: Close, but no cigar. That ingenious device was invented by an accountant and has been used successfully by several taxpayers.
But the IRS has bitterly opposed it. And when it couldn’t get the courts to see its point of view, the agency successfully lobbied Congress. As of this year, the arrangement you described no longer qualifies a taxpayer for an office-at-home tax deduction.
Q: I was in an auto accident several weeks ago. My car was totaled and I was injured, though not seriously. If I combine all the medical costs and the expense of replacing my car, I meet the new tax law’s 10% floor on casualty losses. Otherwise, I don’t. Can I combine the two?--V. C.
A: Sorry, that isn’t permitted. Tax deductions for casualty losses and medical bills cannot be combined, and each is subject to a slightly different floor.
Before this year, taxpayers could deduct their unreimbursed medical expenses to the extent that they exceeded 5% of gross income. Tax reform weakened the value of the deduction--changing the threshold to 7.5% from 5%.
The floor for casualty losses wasn’t changed--it remains at 10% of the taxpayer’s gross income. But filing requirements are different.
Under the old law, a victim of a robbery, car crash or other casualty could take a loss deduction even if he or she decided against reporting the loss to the insurance company for fear of higher insurance rates. Now, no loss deduction is allowed unless a claim is first filed with the insurance company.
