If you used a “margin loan” to raise money for investing last year, the interest you paid
may be considered ”investment interest expense.” Investment interest expense, in turn, is
only deductible on your tax return to the extent of that year’s net investment income.
Dividends that are taxed at the bargain 15 percent rate are not treated as investment
income for purposes of this calculation. Therefore, if you have margin interest you should
consider electing to have a portion of your qualified dividends (or capital gains) taxed at
ordinary income rates on your 2004 tax return, to maximize use of the investment interest
deduction.
Taxpayers may elect to recognize just enough of the qualified dividends to be taxed at
ordinary income tax rates to offset investment interest expense, and allow the remainder of
qualified dividends to be taxed at the lower 15 percent rate.
Alternatively, you can have your dividends and capital gains taxed at 15 percent while
carrying forward non-deductible investment interest expense into a future year. This
strategy might make sense if you don’t expect to incur much margin interest this year and
you think you’ll have sufficient investment income (beyond dividends and long-term gains)
to deduct the interest expense that you carried forward on your 2005 return.
