I Used Cash-Out Refi Loan to Buy Stocks, Can I Deduct the Interests?

[evixdecz]

I cash-out refinanced my house last year and used the cash-out cash to buy stocks.

I did not use the cash to improve the house, but used it to invest in stocks instead.

Can I deduct the interests on that part of the mortgage loan as investment interests like a margin loan?

Thanks.

[DaveF1006]

After conferring with my trusted colleague OPUS 17, I must revise my original answer to this post. You won't be able to claim mortgage interest expense for the refinanced loan because you used the money for something other by building or substantially improving your home. Stock investments do not qualify for a mortgage interest deduction.

In addition, you will not be able to deduct your investment interest expenses unless your investments earned income in 2020 or appreciated in value. If your investments earned income in 2020, you may be able to deduct investment expenses up to the amount of the investment income. In this case, you money you used from the REFI loan used to purchase the investments can be claimed up to the amount of income the investments produced.  You may report the entire cost to you for the investment and any expense over and above the income will be carried over into the following year. Please read this Turbo Tax link for more information. Be sure to maintain accurate records regarding the reporting of your expenses because of the tracing rules that IRS requires for these types of transactions.  Opus 17 has outlined these in detail in a post in this thread.

If you have income from these investments you purchased, you can report the expenses by going to:

1. Log into Turbo Tax
2. Type in 4952 in the search bar at the top of the program. Be sure to press enter after you have done this.
3. Click on jump to 4952 and start recording your information.

[Edited 03-18-2021|05:17 PM PST]

[Opus 17]

[removed as partly incorrect]

[DaveF1006]

I didn't mean to imply that investment interest was deductible. What I did imply was that some of his/her investment expenses may be deductible as costs in managing his investments including certain costs such as broker fees etc. I guess though I didn't make that clear in my post.

[Opus 17]

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@DaveF1006 wrote:

I didn't mean to imply that investment interest was deductible. What I did imply was that some of his/her investment expenses may be deductible as costs in managing his investments including certain costs such as broker fees etc. I guess though I didn't make that clear in my post.

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But that's all still misc itemized deductions under the 2% rule, isn't it?  Is there some other way to deduct investment management fees?

[DaveF1006]

Yes, because Turbo Tax does not specifically define what investment management expenses that can be deducted. it lists a few examples but doesn't narrowly define what is deductible and what is not. 

[Opus 17]

[removed as partly incorrect]

[DaveF1006]

I will actually work out a scenario in my program to see if it will accept the investment expenses. It could be that it is there because it may still be deductible in the state, as you mentioned.  If this is the case, I will revise my original answer and give you credit for my revision.

[Opus 17]

@evixdecz 

Let's go back to square 1 because I messed up.

First, you can't deduct the interest as mortgage interest, because it was not acquisition debt; used to buy, build or remodel your home.  Your deductible mortgage interest is the percentage of debt that is acquisition debt.  Suppose your original mortgage was $50,000 and was all used to buy your house.  Your new cash-out mortgage is $100,000 and you used the other $50,000 for something other than remodeling.  That means that 50% of your mortgage is acquisition debt, and 50% of the interest is deductible.  Turbotax should help with this calculation.

Second, you can deduct investment interest.  This is interest used to buy investments.  This deduction is still allowed even after tax reform.  However, all other investment expenses (advisory fees, record keeping fees, and so on) are no longer deductible.  Also, interest is only deductible up to your investment income.  Suppose you bought stocks that appreciated in value, but you didn't sell them. They also paid $100 in dividends.  That $100 is your income, so you could deduct up to $100 of your interest.  The rest of the interest can be carried forward to be used when you sell the stocks and have a reportable taxable gain.  (You can also declare the gain early to deduct the interest but this is an advanced strategy with many implications and you need to see a professional to do this, let's keep this as simple as we can.)

In Turbotax, the deduction for investment interest is here (this is the Desktop program)

See also this article

https://turbotax.intuit.com/tax-tips/investments-and-taxes/what-are-deductible-investment-interest-e...

Here's the indication that other investment expenses are not tax deductible.

Now thirdly,

Because you don't have a specific loan with only investment interest, you will have to deal with the tracing rules.  The tracing rules require that you be able to prove that a dollar of interest was due to a specific purpose, in this case buying stocks.  The interest on the refi mortgage has two purposes, the mortgage and the stocks.  You will have to keep very good records to show exactly how many dollars of that interest are traceable to the stocks.  If you start using the loan proceeds for other purposes (vacation, home improvements, other debt consolidation) then you get farther and farther away from being able to trace the dollars due to buying the stocks.  The harder it is to trace a dollar of interest back to the stock purchase, the more likely it is that the IRS will disallow the entire deduction if you are audited. 

[Opus 17]

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@DaveF1006 wrote:

I will actually work out a scenario in my program to see if it will accept the investment expenses. It could be that it is there because it may still be deductible in the state, as you mentioned.  If this is the case, I will revise my original answer and give you credit for my revision.

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I think I worked it out, see my revised answer.

[DaveF1006]

You didn't really mess up and I appreciate your answer. You did clarify one point for me though and that these interest expenses would not be deductible unless there is income from the investment or an appreciation in the value of the stock. These would be reported on  Form 4952. 

For future reference, I have saved your answer for any future posts regarding subject. Thank you so much for clarifying this and I will edit my original answer.

[evixdecz]

Great info.

Thanks guys.

[prash]

@Opus 17 

When you have short term capital gains, you can offset with

1.)Past carryover losses

2.)Investment Interest Expense

Question:

1.)Which ones take priority?

2.)If i go with standard deduction every year, can I accumulate the margin-interest(aka investment interest expense), and add it up, until the day I can itemized and offset it in future years?

[Opus 17]

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@prash wrote:

@Opus 17 

When you have short term capital gains, you can offset with

1.)Past carryover losses

2.)Investment Interest Expense

Question:

1.)Which ones take priority?

2.)If i go with standard deduction every year, can I accumulate the margin-interest(aka investment interest expense), and add it up, until the day I can itemized and offset it in future years?

---

Short term loss carryovers are applied to short term gains, and long term loss carryovers are applied to long term gains.  This is done directly on Schedule D.

Investment interest can be deducted up to the amount of net investment income.  Net income is income after any other deductions including carryovers, so the interest is deducted against any net income after carryovers.

You must list your investment interest expense as a deduction every year, take any allowable deduction, and track your carryforward on form 4952.  You can't just pop up 10 years later and claim 10 years worth of interest.

https://www.irs.gov/pub/irs-pdf/f4952.pdf

Also, you will need to review form 4952 and its instructions carefully and perhaps seek professional advice.  Based on the instructions to form 4952, "investment income" does NOT include capital gains or qualified dividends.  (It would include ordinary taxable income such as non-qualified dividends, or rental income on schedule E for example, but does not include capital gains.)

There is an option to treat capital gains as ordinary income on line 4g of form 4952, but this means that the capital gains income will be taxed as ordinary income instead of at lower capital gains rates.  This is a complicated situation that I have not studied, and whether this is a net benefit to you is something I can't address.  (I suppose it would be a net benefit if you had enough interest expense to deduct against the income, but I'm not sure.). 

Further professional advice is recommended.

[prash]

Thanks for clarification.

Is my understanding correct, that for the years, i take standard deduction, i lose the investment-interest-expense benefit.

year-1: Standard Deduction. No benefit on investment-interest-expense

year-2: Itemized Deduction. investment-interest-expense > investment-income. $100 carryover expense

year-3: Standard Deduction. No benefit

year-10:Itemized Deduction. Pull carryover from year-2 to do offset with investment-income?

Are year-2 and year-10 details, i mentioned, are those possible and allowed. That is my question.