the IRS has tracing rules, REG 1.163-8T, which basically say to look to what the borrowings were used for to determine if and where they are deductible. since your margin loans would be used to buy more real estate the deduction would be related to the real estate and not be schedule A investment interest
what you must be careful of is what is referred to as debt-fianced distributions.
A debt-financed distribution occurs when a passthrough entity, such as your LLC, secures debt and then distributes a portion of the debt proceeds to its owners. then the deductibility of the interest to the partner depends on what distribution proceeds are used for. Under Temporary Regulations Sec. 1.163-8T and IRS Notice 89-35, there are two ways by which the debt proceeds and related interest expense may be allocated by the passthrough entity. The first is the general allocation rule, which allows for the allocation of the interest expense to be in accordance with each owner’s use of the debt proceeds. The second and more practical method, known as the optional allocation rule, permits the allocation of the distributed debt proceeds and the associated interest expense to one or more expenditures made during the same taxable year as the distribution.
The owner’s share of the passthrough entity’s interest expense on debt proceeds allocated to distributions to owners should be included on the “other deductions” line on the IRS Form 1065, Schedule K-1 and identified as “interest expense allocated to debt-financed distributions.”
If the received debt proceeds were used for income-producing activities or investments, the related interest expense to the owner is deductible. But, if the debt proceeds were used for items of personal in nature (i.e. buying a boat), then the related interest expense would not be deductible to the owner.
