Using Excess Investment Interest Expense From Previous Years (Form 4952) and Current Year Investment Interest Expense

[JJ99000]

Hello, 

Thank you in advance for any information.

On my CY2023 return (filed in April 2024), I had carry-forward capital losses shown on Schedule D, and excess investment interest expense shown on Form 4952 . During CY2024, I have also have incurred investment interet expenses. 

For my upcoing CY2024 tax return, Turbotax will likely eliminate the capital loss carry-forwards if there are sufficient realized capital gains during the year. It would not seem to matter much if the realized capital gains for CY2024 are long-term or short-term, but the system will likely first try to match short-term capital gains to short-term loss carry forwards.

So far during CY2024, there are more realized short-term capital gains than long-term capital gains. It is my understanding that ultimately any type of realized capital gain, either long-term or short-term, will eliminate any kind  of capital loss carry-forwards, either long-term or short-term. There are more long-term capital loss carry-forward than short-term. 

If there is good fortune later in CY2024, and total capital gains, either short-term or long-term, exceed all the capital loss carry-forwards shown on Schedule D, will TurboTax automatically apply all of the investment interest expenses incurred (both the carry-forward values shown on Form 4952 and the amount incurred during CY2024) to eliminate the tax obligation (Federal, State of NY, and 3.8% surcharge) on additional short-term capital gains, and ask me if I would like to elect to use investmnt interest expense to cover any additional long-term capital gains?

Are there any limitations to the ability to use the investment interest expense for any one tax year? I read that any time there is an election to use the investment interest expense to cover long-term capital gains that the tax filer must itemize deductions, presumably even if the itemized deductions turns out to be below the standard deduction, as would be the case if real estate taxes max out at $10,000 and if there is no mortgage interest expense). The filer can still file and benefit from the election, but must forgo use of the standard deduction which would normally help the tax filer.  

Thank you kindly!

JJ 

[Mike9241]

by default qualified dividends (QD) and net long-term capital gains (LTCG) are excluded from investment income for purposes of determining deductible investment interest.  you can make an election to include as much QD and LTCD as you want if needed or wanted to increase the deduction for investment interest expense.

doing so will disqualify those amounts for the special rate that QD and LTCG get. 

[JJ99000]

Thank you Mike. 

By making the election to use investment interest expense to cover net long-term capital gainst (LTCD) and qualified dividends (QD), is "disqualifying those amounts for the special rate that QD and LTCG get" not important because by making the deducting, there would be no amount to actually tax? So the election avoids Federal taxes and potentially the 3.8% surcharge if the gains are large enough? I believe NY would match Federal tax treatment, so there would be no NY State/Local Taxes due as well? Does this sound accurate to you?

[JJ99000]

Thank you MIke, 

Electing to use investment interest expenses (prior and current years) to cover long-term capital gains, despite the loss of favorable tax rates normally applied to long-term capital gains (LTCG), would seem to incur no Federal tax, 3.8% surcharge, or NY State/City taxes. If there is no annual limitation on the amount a filer can elect to cover LTCG or QD,  the election could eliminate all that tax, which could be +/- 30%. The LTCG would not be subject to tax at the federal level, and that NY State/City would mirror the Federal tax treatment making it untaxed at each such jurisdiction? Does this sound accurate?

[Mike9241]

For Federal using prior/current  years is not an election. By default, both are included in the current year limitation computation previously mentioned. there is no option to forgo using it.  review form 4952 and instructions. to repeat using qualified dividends and LTCG is an option.

https://www.irs.gov/site-index-search?search=4952&field_pup_historical_1=1&field_pup_historical=1 

can't answer for New York

[JJ99000]

Thank you. I am trying to follow the terminology, as not an accountant. 

I see on Form 4952, the following language,

"In general, qualified dividends and net capital gain from the disposition of property held for investment are excluded from investment income. But you can elect to include part or all of these amounts in investment income....The qualified dividends and net capital gain that you elect to include in investment income on line 4g aren’t eligible to be taxed at the qualified dividends or capital gains tax rates. You should consider the tax effect of using the qualified dividends and capital gains tax rates before making this election. Once made, the election can be revoked only with IRS consent." 

I understand that by making the election to use investment interest expense to cover long-term capital gains would be disadvantageous if there is interest income that would otherwise be taxed at ordinary income rates. Beyond that, I see no disbenefit to applying the interest expense to fully cover taxes due on realized long-term capital gains.  

If anyone agrees or knows if NY State matches federal tax treatment in this regard, there would seem to be no tax due whatseoever when making such an election.