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Author: TMFTaxes Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 121434  
Subject: Re: Margin Interest Date: 4/25/1997 1:57 PM
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On Thu, 24 Apr 97 14:02:18 -0600, dmeredit wrote:
<<

I will probably be incuring significant (in the hundreds of dollars) in margin interest this year. I did this as I wanted to get into certain stocks earlier in the year, in anticipation of my bonus (which has since paid off most of the interest).



My question is, if I make no short term capital gains this year, how can I get the tax advantage for the margin interest. Last year I made some ST capital gains and was able to offset some of these with the margin interest, but I understand that it is different for LT Capital Gains.



Also, if I made some ST capital loses, can these be used to offset against my personal income or only against other short term capital gains.



Thanks for any help.>>

Understand that Investment Interest is an animal in and of itself. It has it's own separate rules and restrictions. To learn more about Investment Interest, you'll what to check out IRS Form 4952 and instructions, and IRS Publication 550. That will provide you with significant information that will be useful to you and your tax planning. Remember also that investment interest is treated as an itemized deduction, so if you are not able to itemize your deductions, your Investment Interest may be of very little value to you.

Now then, you make a reference to long term capital gains. You should know that for tax years after 192, net investment income does NOT include LTCG. An election is available to treat all or part of the net LTCG as investment income, provided that you reduce the amount of net LTCG eligible for the 28% maximum capital gains rate by the same amount. This election is made by completing Form 4952. So, as you can imagine, this election becomes significant if your "normal" tax rate is greater than 28%. But if your "normal" tax rate is 28% or less, the importance of the maximum tax for LTCGs becomes moot, and you will generally make the election to treat ALL LTCGs as investment income. But lets look at an example:

Lets say that you are a single taxpayer, and your income and expenses for 1996 look like this:
WAGES.....................$80,000
INTEREST INCOME............$3,000
LONG TERM CAPITAL GAIN.....$6,000
INVESTMENT INTEREST EXPENSE$5,000
OTHER ITEMIZED DEDUCTIONS..$4,000

So, given these facts, if you do NOT make the election to treat LTCGs as investment income, the Investment Interest expense will be limited to $3,000 (your interest income). The tax using the Schedule D worksheet would equal $19,585 (trust me). You would then have $2,000 of Investment Interest expense to carry forward to 1997.

BUT, if you would elect to treat the $2,000 of capital gains as investment income, the FULL $5,000 of Investment Interest expense is deductible, and the tax using the Schedule D worksheet would equal $19,025. This is a tax savings of $560. And you would have NO Investment Interest expense to carry over to 1997.

See how it works?? So sometimes the obvious may not be so obvious. You really need to check out YOUR specific tax situation to see how the Investmtne Interest will apply to you, and if you want to make the election to treat LTCGs as investment income.

As far as your short term loss question, you might want to review my previous post that briefly explains how Schedule D works relative to gains and losses. But, in short, your net ST capital losses are combined with your ST capital gains. Then you combine your LT capital losses against your LT capital gains. Then you combine the whole mess. The answer will be one of the following:

1. Net ST capital gain, which will be taxed at your "normal" tax rate
2. Net ST capital loss. You can use up to $3,000 of this loss to offset any other income. Any loss in addition to the $3,000 can be carried over to future years, to be combined with any other ST or LT gains (beginning the Schedule D process all over again)
3. Net LT capital gain, which will be subject to a MAX tax of 28%
4. Net LT capital loss. Treated the same as a ST capital loss, with the $3,000 limitation.

So it is certainly possible, if your losses are great enough, to offset your "regular" income, at least up to $3,000 in any one year.

Sure hope this helps. If you have any other specific questions, post 'em here.

TMF Taxes
Roy Lewis
A Fool

All of that being said, lets look at your specific questions. The deduction of Investment Interest is NOT predicated only on short term or long term gains. Investment Interest is deductible up to the amount of "net investment income" received. "Net investment income" generally includes gross income derived from property held for investment (duhhh...but that's how the IRS defines it). Examples of investment include interest, dividends, capital gains (both short term and elective long term), annuities, royalties, and investment income of a child under age 14, reported on the parent's tax return (Form 8814). So as you can see, Investment Interest is not predicated ONLY on capital gains.



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