Brokerage firms may allow you to invest on margin, borrowing to buy stocks. You’ll pay relatively low interest rates (around 6%-8% today) and that interest might be deductible. For margin loan interest to be deductible, the proceeds must be used solely to buy securities or investment property. If you use the proceeds to buy a car or take a vacation, the interest will be considered nondeductible personal interest.
For full deductibility, you’ll need enough investment income to completely offset the margin loan interest you pay. Investment income includes interest, dividends, and, if necessary, capital gains. However, if your portfolio is heavily weighted towards stocks, you may not have much in the way of interest or dividends from your investments. Buy-and-hold investors may not have many capital gains to offset, either. In that case, some or most of your margin interest won’t be deductible.
Yet another tax headache may arise: margin interest isn’t deductible if it’s used to buy or hold municipal bonds or bond funds. If municipal bonds represent 10% of the assets in your brokerage account, for example, you can write off no more than 90% of your investment interest.
