Investors may wish to buy stocks on margin. If the stocks go up in price, the leverage will increase your profits. Buying stocks with borrowed funds boosts the risks as well the potential returns but today’s low interest rates make such a strategy more attractive.
The tax treatment of margin investing is tricky, though. The interest on margin loans may be tax-deductible–such loans can produce investment interest expense, which is deductible up to the amount of net investment income.
The catch? Dividends that qualify for the 15 percent maximum rate don’t count as investment income for the investment interest expense deduction. If your only investment income comes from dividends, you won’t get to deduct the margin interest you pay. On the other hand, if you also have interest income and short-term capital gains, you can deduct margin interest against that income while you’ll still get the bargain 15 percent tax rate on dividend income and long-term capital gains.
