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1040 nrez Publication 926 - Introductory Material Table of Contents Future Developments What's New Reminder IntroductionTax questions. 1040 nrez Future Developments For the latest information about developments related to Publication 926, such as legislation enacted after it was published, go to www. 1040 nrez irs. 1040 nrez gov/pub926. 1040 nrez What's New Social security and Medicare tax for 2014. 1040 nrez  The social security tax rate is 6. 1040 nrez 2% each for the employee and employer, unchanged from 2013. 1040 nrez The social security wage base limit is $117,000. 1040 nrez The Medicare tax rate is 1. 1040 nrez 45% each for the employee and employer, unchanged from 2013. 1040 nrez There is no wage base limit for Medicare tax. 1040 nrez Social security and Medicare taxes apply to the wages of household employees you pay $1,900 or more in cash or an equivalent form of compensation. 1040 nrez Qualified parking exclusion and commuter transportation benefit. 1040 nrez  For 2014, the monthly exclusion for qualified parking is $250 and the monthly exclusion for commuter highway vehicle transportation and transit passes is $130. 1040 nrez Reminder Additional Medicare Tax withholding. 1040 nrez  In addition to withholding Medicare tax at 1. 1040 nrez 45%, you must withhold a 0. 1040 nrez 9% Additional Medicare Tax from wages you pay to an employee in excess of $200,000 in a calendar year. 1040 nrez You are required to begin withholding Additional Medicare Tax in the pay period in which you pay wages in excess of $200,000 to an employee and continue to withhold it each pay period until the end of the calendar year. 1040 nrez Additional Medicare Tax is only imposed on the employee. 1040 nrez There is no employer share of Additional Medicare Tax. 1040 nrez All wages that are subject to Medicare tax are subject to Additional Medicare Tax withholding if paid in excess of the $200,000 withholding threshold. 1040 nrez For more information on Additional Medicare Tax, visit IRS. 1040 nrez gov and enter “Additional Medicare Tax” in the search box. 1040 nrez Credit reduction states. 1040 nrez  A state that has not repaid money it borrowed from the federal government to pay unemployment benefits is a “credit reduction state. 1040 nrez ” The Department of Labor (DOL) determines these states. 1040 nrez If you paid any wages that are subject to the unemployment compensation laws in any credit reduction state, your federal unemployment (FUTA) tax credit is reduced. 1040 nrez See the Instructions for Schedule H (Form 1040) for more information. 1040 nrez Outsourcing payroll duties. 1040 nrez  Employers are responsible to ensure that tax returns are filed and deposits and payments are made, even if the employer contracts with a third party to perform these acts. 1040 nrez The employer remains responsible if the third party fails to perform any required action. 1040 nrez If you choose to outsource any of your payroll and related tax duties (that is, withholding, reporting, and paying over social security, Medicare, FUTA, and income taxes) to a third-party payer such as a payroll service provider or reporting agent, visit IRS. 1040 nrez gov and enter “outsourcing payroll duties” in the search box for helpful information on this topic. 1040 nrez Photographs of missing children. 1040 nrez  The IRS is a proud partner with the National Center for Missing and Exploited Children. 1040 nrez Photographs of missing children selected by the Center may appear in this publication on pages that would otherwise be blank. 1040 nrez You can help bring these children home by looking at the photographs and calling 1-800-THE-LOST (1-800-843-5678) if you recognize a child. 1040 nrez Introduction The information in this publication applies to you only if you have a household employee. 1040 nrez If you have a household employee in 2014, you may need to pay state and federal employment taxes for 2014. 1040 nrez You generally must add your federal employment taxes to the income tax that you will report on your 2014 federal income tax return. 1040 nrez This publication will help you decide whether you have a household employee and, if you do, whether you need to pay federal employment taxes (social security tax, Medicare tax, FUTA, and federal income tax withholding). 1040 nrez It explains how to figure, pay, and report these taxes for your household employee. 1040 nrez It also explains what records you need to keep. 1040 nrez This publication also tells you where to find out whether you need to pay state unemployment tax for your household employee. 1040 nrez Comments and suggestions. 1040 nrez   We welcome your comments about this publication and your suggestions for future editions. 1040 nrez   You can write to us at the following address: Internal Revenue Service Tax Forms and Publications Division 1111 Constitution Ave. 1040 nrez NW, IR-6526 Washington, DC 20224   We respond to many letters by telephone. 1040 nrez Therefore, it would be helpful if you would include your daytime phone number, including the area code, in your correspondence. 1040 nrez   You can also send us comments from www. 1040 nrez irs. 1040 nrez gov/formspubs. 1040 nrez Click on More Information and then click on Comment on Tax Forms and Publications. 1040 nrez   Although we cannot respond individually to each comment received, we do appreciate your feedback and will consider your comments as we revise our tax products. 1040 nrez Tax questions. 1040 nrez   If you have a tax question, check the information available on IRS. 1040 nrez gov or call 1-800-829-1040 or 1-800-829-4933 (TDD/TTY for persons who are deaf, hard of hearing, or have a speech disability at 1-800-829-4059) Monday–Friday from 7:00 a. 1040 nrez m. 1040 nrez –7:00 p. 1040 nrez m. 1040 nrez local time (Alaska and Hawaii follow Pacific time). 1040 nrez We cannot answer tax questions sent to the above address. 1040 nrez Prev  Up  Next   Home   More Online Publications
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1040 nrez 3. 1040 nrez   Investment Expenses Table of Contents Topics - This chapter discusses: Useful Items - You may want to see: Limits on DeductionsPassive activity. 1040 nrez Other income (nonpassive income). 1040 nrez Expenses. 1040 nrez Additional information. 1040 nrez Interest ExpensesInvestment Interest Limit on Deduction Bond Premium AmortizationSpecial rules to determine amounts payable on a bond. 1040 nrez Basis. 1040 nrez How To Figure Amortization Choosing To Amortize How To Report Amortization Expenses of Producing IncomeFees to buy or sell. 1040 nrez Including mutual fund or REMIC expenses in income. 1040 nrez Nondeductible ExpensesUsed as collateral. 1040 nrez Short-sale expenses. 1040 nrez Expenses for both tax-exempt and taxable income. 1040 nrez State income taxes. 1040 nrez Nondeductible amount. 1040 nrez Basis adjustment. 1040 nrez How To Report Investment Expenses When To Report Investment Expenses Topics - This chapter discusses: Limits on Deductions , Interest Expenses , Bond Premium Amortization , Expenses of Producing Income , Nondeductible Expenses , How To Report Investment Expenses , and When To Report Investment Expenses . 1040 nrez Useful Items - You may want to see: Publication 535 Business Expenses 925 Passive Activity and At-Risk Rules 929 Tax Rules for Children and Dependents Form (and Instructions) Schedule A (Form 1040) Itemized Deductions 4952 Investment Interest Expense Deduction See chapter 5, How To Get Tax Help , for information about getting these publications and forms. 1040 nrez Limits on Deductions Your deductions for investment expenses may be limited by: The at-risk rules, The passive activity loss limits, The limit on investment interest, or The 2% limit on certain miscellaneous itemized deductions. 1040 nrez The at-risk rules and passive activity rules are explained briefly in this section. 1040 nrez The limit on investment interest is explained later in this chapter under Interest Expenses . 1040 nrez The 2% limit is explained later in this chapter under Expenses of Producing Income . 1040 nrez At-risk rules. 1040 nrez   Special at-risk rules apply to most income-producing activities. 1040 nrez These rules limit the amount of loss you can deduct to the amount you risk losing in the activity. 1040 nrez Generally, this is the cash and the adjusted basis of property you contribute to the activity. 1040 nrez It also includes money you borrow for use in the activity if you are personally liable for repayment or if you use property not used in the activity as security for the loan. 1040 nrez For more information, see Publication 925. 1040 nrez Passive activity losses and credits. 1040 nrez   The amount of losses and tax credits you can claim from passive activities is limited. 1040 nrez Generally, you are allowed to deduct passive activity losses only up to the amount of your passive activity income. 1040 nrez Also, you can use credits from passive activities only against tax on the income from passive activities. 1040 nrez There are exceptions for certain activities, such as rental real estate activities. 1040 nrez Passive activity. 1040 nrez   A passive activity generally is any activity involving the conduct of any trade or business in which you do not materially participate and any rental activity. 1040 nrez However, if you are involved in renting real estate, the activity is not a passive activity if both of the following are true. 1040 nrez More than one-half of the personal services you perform during the year in all trades or businesses are performed in real property trades or businesses in which you materially participate. 1040 nrez You perform more than 750 hours of services during the year in real property trades or businesses in which you materially participate. 1040 nrez  The term “trade or business” generally means any activity that involves the conduct of a trade or business, is conducted in anticipation of starting a trade or business, or involves certain research or experimental expenditures. 1040 nrez However, it does not include rental activities or certain activities treated as incidental to holding property for investment. 1040 nrez   You are considered to materially participate in an activity if you are involved on a regular, continuous, and substantial basis in the operations of the activity. 1040 nrez Other income (nonpassive income). 1040 nrez    Generally, you can use losses from passive activities only to offset income from passive activities. 1040 nrez You cannot use passive activity losses to offset your other income, such as your wages or your portfolio income. 1040 nrez Portfolio income includes gross income from interest, dividends, annuities, or royalties that is not derived in the ordinary course of a trade or business. 1040 nrez It also includes gains or losses (not derived in the ordinary course of a trade or business) from the sale or trade of property (other than an interest in a passive activity) producing portfolio income or held for investment. 1040 nrez This includes capital gain distributions from mutual funds (and other regulated investment companies) and real estate investment trusts. 1040 nrez   You cannot use passive activity losses to offset Alaska Permanent Fund dividends. 1040 nrez Expenses. 1040 nrez   Do not include in the computation of your passive activity income or loss: Expenses (other than interest) that are clearly and directly allocable to your portfolio income, or Interest expense properly allocable to portfolio income. 1040 nrez However, this interest and other expenses may be subject to other limits. 1040 nrez These limits are explained in the rest of this chapter. 1040 nrez Additional information. 1040 nrez   For more information about determining and reporting income and losses from passive activities, see Publication 925. 1040 nrez Interest Expenses This section discusses interest expenses you may be able to deduct as an investor. 1040 nrez For information on business interest, see chapter 4 of Publication 535. 1040 nrez You cannot deduct personal interest expenses other than qualified home mortgage interest, as explained in Publication 936, Home Mortgage Interest Deduction, and interest on certain student loans, as explained in Publication 970. 1040 nrez Investment Interest If you borrow money to buy property you hold for investment, the interest you pay is investment interest. 1040 nrez You can deduct investment interest subject to the limit discussed later. 1040 nrez However, you cannot deduct interest you incurred to produce tax-exempt income. 1040 nrez See Tax-exempt income under Nondeductible Expenses, later. 1040 nrez You also cannot deduct interest expenses on straddles discussed under Interest expense and carrying charges on straddles , later. 1040 nrez Investment interest does not include any qualified home mortgage interest or any interest taken into account in computing income or loss from a passive activity. 1040 nrez Investment property. 1040 nrez   Property held for investment includes property that produces interest, dividends, annuities, or royalties not derived in the ordinary course of a trade or business. 1040 nrez It also includes property that produces gain or loss (not derived in the ordinary course of a trade or business) from the sale or trade of property producing these types of income or held for investment (other than an interest in a passive activity). 1040 nrez Investment property also includes an interest in a trade or business activity in which you did not materially participate (other than a passive activity). 1040 nrez Partners, shareholders, and beneficiaries. 1040 nrez   To determine your investment interest, combine your share of investment interest from a partnership, S corporation, estate, or trust with your other investment interest. 1040 nrez Allocation of Interest Expense If you borrow money for business or personal purposes as well as for investment, you must allocate the debt among those purposes. 1040 nrez Only the interest expense on the part of the debt used for investment purposes is treated as investment interest. 1040 nrez The allocation is not affected by the use of property that secures the debt. 1040 nrez Example 1. 1040 nrez You borrow $10,000 and use $8,000 to buy stock. 1040 nrez You use the other $2,000 to buy items for your home. 1040 nrez Since 80% of the debt is used for, and allocated to, investment purposes, 80% of the interest on that debt is investment interest. 1040 nrez The other 20% is nondeductible personal interest. 1040 nrez Debt proceeds received in cash. 1040 nrez   If you receive debt proceeds in cash, the proceeds are generally not treated as investment property. 1040 nrez Debt proceeds deposited in account. 1040 nrez   If you deposit debt proceeds in an account, that deposit is treated as investment property, regardless of whether the account bears interest. 1040 nrez But, if you withdraw the funds and use them for another purpose, you must reallocate the debt to determine the amount considered to be for investment purposes. 1040 nrez Example 2. 1040 nrez Assume in Example 1 that you borrowed the money on March 1 and immediately bought the stock for $8,000. 1040 nrez You did not buy the household items until June 1. 1040 nrez You had deposited the $2,000 in the bank. 1040 nrez You had no other transactions on the bank account until June. 1040 nrez You did not sell the stock, and you made no principal payments on the debt. 1040 nrez You paid interest from another account. 1040 nrez The $8,000 is treated as being used for an investment purpose. 1040 nrez The $2,000 is treated as being used for an investment purpose for the 3-month period. 1040 nrez Your total interest expense for 3 months on this debt is investment interest. 1040 nrez In June, when you spend the $2,000 for household items, you must begin to allocate 80% of the debt and the interest expense to investment purposes and 20% to personal purposes. 1040 nrez Amounts paid within 30 days. 1040 nrez   If you receive loan proceeds in cash or if the loan proceeds are deposited in an account, you can treat any payment (up to the amount of the proceeds) made from any account you own, or from cash, as made from those proceeds. 1040 nrez This applies to any payment made within 30 days before or after the proceeds are received in cash or deposited in your account. 1040 nrez   If you received the loan proceeds in cash, you can treat the payment as made on the date you received the cash instead of the date you actually made the payment. 1040 nrez Payments on debt may require new allocation. 1040 nrez   As you repay a debt used for more than one purpose, you must reallocate the balance. 1040 nrez You must first reduce the amount allocated to personal purposes by the repayment. 1040 nrez You then reallocate the rest of the debt to find what part is for investment purposes. 1040 nrez Example 3. 1040 nrez If, in Example 2 , you repay $500 on November 1, the entire repayment is applied against the amount allocated to personal purposes. 1040 nrez The debt balance is now allocated as $8,000 for investment purposes and $1,500 for personal purposes. 1040 nrez Until the next reallocation is necessary, 84% ($8,000 ÷ $9,500) of the debt and the interest expense is allocated to investment. 1040 nrez Pass-through entities. 1040 nrez   If you use borrowed funds to buy an interest in a partnership or S corporation, then the interest on those funds must be allocated based on the assets of the entity. 1040 nrez If you contribute to the capital of the entity, you can make the allocation using any reasonable method. 1040 nrez Additional allocation rules. 1040 nrez   For more information about allocating interest expense, see chapter 4 of Publication 535. 1040 nrez When To Deduct Investment Interest If you use the cash method of accounting, you must pay the interest before you can deduct it. 1040 nrez If you use an accrual method of accounting, you can deduct interest over the period it accrues, regardless of when you pay it. 1040 nrez For an exception, see Unpaid expenses owed to related party under When To Report Investment Expenses, later in this chapter. 1040 nrez Example. 1040 nrez You borrowed $1,000 on August 26, 2013, payable in 90 days at 12% interest. 1040 nrez On November 26, 2013, you paid this with a new note for $1,030, due on February 26, 2014. 1040 nrez If you use the cash method of accounting, you cannot deduct any part of the $30 interest on your return for 2013 because you did not actually pay it. 1040 nrez If you use an accrual method, you may be able to deduct a portion of the interest on the loans through December 31, 2013, on your return for 2013. 1040 nrez Interest paid in advance. 1040 nrez   Generally, if you pay interest in advance for a period that goes beyond the end of the tax year, you must spread the interest over the tax years to which it belongs under the OID rules discussed in chapter 1. 1040 nrez You can deduct in each year only the interest for that year. 1040 nrez Interest on margin accounts. 1040 nrez   If you are a cash method taxpayer, you can deduct interest on margin accounts to buy taxable securities as investment interest in the year you paid it. 1040 nrez You are considered to have paid interest on these accounts only when you actually pay the broker or when payment becomes available to the broker through your account. 1040 nrez Payment may become available to the broker through your account when the broker collects dividends or interest for your account, or sells securities held for you or received from you. 1040 nrez   You cannot deduct any interest on money borrowed for personal reasons. 1040 nrez Limit on interest deduction for market discount bonds. 1040 nrez   The amount you can deduct for interest expense you paid or accrued during the year to buy or carry a market discount bond may be limited. 1040 nrez This limit does not apply if you accrue the market discount and include it in your income currently. 1040 nrez   Under this limit, the interest is deductible only to the extent it is more than: The total interest and OID includible in gross income for the bond for the year, plus The market discount for the number of days you held the bond during the year. 1040 nrez Figure the amount in (2) above using the rules for figuring accrued market discount in chapter 1 under Market Discount Bonds . 1040 nrez Interest not deducted due to limit. 1040 nrez   In the year you dispose of the bond, you can deduct any interest expense you were not allowed to deduct in earlier years because of the limit. 1040 nrez Choosing to deduct disallowed interest expense before the year of disposition. 1040 nrez   You can choose to deduct disallowed interest expense in any year before the year you dispose of the bond, up to your net interest income from the bond during the year. 1040 nrez The rest of the disallowed interest expense remains deductible in the year you dispose of the bond. 1040 nrez Net interest income. 1040 nrez   This is the interest income (including OID) from the bond that you include in income for the year, minus the interest expense paid or accrued during the year to purchase or carry the bond. 1040 nrez Limit on interest deduction for short-term obligations. 1040 nrez   If the current income inclusion rules discussed in chapter 1 under Discount on Short-Term Obligations do not apply to you, the amount you can deduct for interest expense you paid or accrued during the year to buy or carry a short-term obligation is limited. 1040 nrez   The interest is deductible only to the extent it is more than: The amount of acquisition discount or OID on the obligation for the tax year, plus The amount of any interest payable on the obligation for the year that is not included in income because of your accounting method (other than interest taken into account in determining the amount of acquisition discount or OID). 1040 nrez The method of determining acquisition discount and OID for short-term obligations is discussed in chapter 1 under Discount on Short-Term Obligations . 1040 nrez Interest not deducted due to limit. 1040 nrez   In the year you dispose of the obligation, or, if you choose, in another year in which you have net interest income from the obligation, you can deduct any interest expense you were not allowed to deduct for an earlier year because of the limit. 1040 nrez Follow the same rules provided in the earlier discussion under Limit on interest deduction for market discount bonds , earlier. 1040 nrez Limit on Deduction Generally, your deduction for investment interest expense is limited to your net investment income. 1040 nrez You can carry over the amount of investment interest you could not deduct because of this limit to the next tax year. 1040 nrez The interest carried over is treated as investment interest paid or accrued in that next year. 1040 nrez You can carry over disallowed investment interest to the next tax year even if it is more than your taxable income in the year the interest was paid or accrued. 1040 nrez Net Investment Income Determine the amount of your net investment income by subtracting your investment expenses (other than interest expense) from your investment income. 1040 nrez Investment income. 1040 nrez   This generally includes your gross income from property held for investment (such as interest, dividends, annuities, and royalties). 1040 nrez Investment income does not include Alaska Permanent Fund dividends. 1040 nrez It also does not include qualified dividends or net capital gain unless you choose to include them. 1040 nrez Choosing to include qualified dividends. 1040 nrez   Investment income generally does not include qualified dividends, discussed in chapter 1. 1040 nrez However, you can choose to include all or part of your qualified dividends in investment income. 1040 nrez   You make this choice by completing Form 4952, line 4g, according to its instructions. 1040 nrez   If you choose to include any of your qualified dividends in investment income, you must reduce your qualified dividends that are eligible for the lower capital gains tax rates by the same amount. 1040 nrez Choosing to include net capital gain. 1040 nrez    Investment income generally does not include net capital gain from disposing of investment property (including capital gain distributions from mutual funds). 1040 nrez However, you can choose to include all or part of your net capital gain in investment income. 1040 nrez   You make this choice by completing Form 4952, line 4g, according to its instructions. 1040 nrez   If you choose to include any of your net capital gain in investment income, you must reduce your net capital gain that is eligible for the lower capital gains tax rates by the same amount. 1040 nrez   For more information about the capital gains rates, see Capital Gain Tax Rates in chapter 4. 1040 nrez    Before making either choice, consider the overall effect on your tax liability. 1040 nrez Compare your tax if you make one or both of these choices with your tax if you do not. 1040 nrez Investment income of child reported on parent's return. 1040 nrez   Investment income includes the part of your child's interest and dividend income you choose to report on your return. 1040 nrez If the child does not have qualified dividends, Alaska Permanent Fund dividends, or capital gain distributions, this is the amount on line 6 of Form 8814. 1040 nrez Include it on line 4a of Form 4952. 1040 nrez Example. 1040 nrez Your 8-year-old son has interest income of $2,200, which you choose to report on your own return. 1040 nrez You enter $2,200 on Form 8814, lines 1a and 4, and $200 on lines 6 and 12 and complete Part II. 1040 nrez Also enter $200 on Form 1040, line 21. 1040 nrez Your investment income includes this $200. 1040 nrez Child's qualified dividends. 1040 nrez   If part of the amount you report is your child's qualified dividends, that part (which is reported on Form 1040, line 9b) generally does not count as investment income. 1040 nrez However, you can choose to include all or part of it in investment income, as explained under Choosing to include qualified dividends , earlier. 1040 nrez   Your investment income also includes the amount on Form 8814, line 12 (or, if applicable, the reduced amount figured next under Child's Alaska Permanent Fund dividends). 1040 nrez Child's Alaska Permanent Fund dividends. 1040 nrez   If part of the amount you report is your child's Alaska Permanent Fund dividends, that part does not count as investment income. 1040 nrez To figure the amount of your child's income that you can consider your investment income, start with the amount on Form 8814, line 6. 1040 nrez Multiply that amount by a percentage that is equal to the Alaska Permanent Fund dividends divided by the total amount on Form 8814, line 4. 1040 nrez Subtract the result from the amount on Form 8814, line 12. 1040 nrez Example. 1040 nrez Your 10-year-old child has taxable interest income of $4,000 and Alaska Permanent Fund dividends of $2,000. 1040 nrez You choose to report this on your return. 1040 nrez You enter $4,000 on Form 8814, line 1a, $2,000 on line 2a, and $6,000 on line 4. 1040 nrez You then enter $4,000 on Form 8814, lines 6 and 12, and Form 1040, line 21. 1040 nrez You figure the amount of your child's income that you can consider your investment income as follows: $4,000 − ($4,000 × ($2,000 ÷ $6,000)) = $2,667 You include the result, $2,667, on Form 4952, line 4a. 1040 nrez Child's capital gain distributions. 1040 nrez   If part of the amount you report is your child's capital gain distributions, that part (which is reported on Schedule D (Form 1040), line 13, or Form 1040, line 13) generally does not count as investment income. 1040 nrez However, you can choose to include all or part of it in investment income, as explained in Choosing to include net capital gain , earlier. 1040 nrez   Your investment income also includes the amount on Form 8814, line 12 (or, if applicable, the reduced amount figured under Child's Alaska Permanent Fund dividends , earlier). 1040 nrez Investment expenses. 1040 nrez   Investment expenses are your allowed deductions (other than interest expense) directly connected with the production of investment income. 1040 nrez Investment expenses that are included as a miscellaneous itemized deduction on Schedule A (Form 1040) are allowable deductions after applying the 2% limit that applies to miscellaneous itemized deductions. 1040 nrez Use the smaller of: The investment expenses included on Schedule A (Form 1040), line 23, or The amount on Schedule A (Form 1040), line 27. 1040 nrez See Expenses of Producing Income , later, for a discussion of the 2% limit. 1040 nrez Losses from passive activities. 1040 nrez   Income or expenses that you used in computing income or loss from a passive activity are not included in determining your investment income or investment expenses (including investment interest expense). 1040 nrez See Publication 925 for information about passive activities. 1040 nrez Example. 1040 nrez Ted is a partner in a partnership that operates a business. 1040 nrez However, he does not materially participate in the partnership's business. 1040 nrez Ted's interest in the partnership is considered a passive activity. 1040 nrez Ted's investment income from interest and dividends (other than qualified dividends) is $10,000. 1040 nrez His investment expenses (other than interest) are $3,200 after taking into account the 2% limit on miscellaneous itemized deductions. 1040 nrez His investment interest expense is $8,000. 1040 nrez Ted also has income from the partnership of $2,000. 1040 nrez Ted figures his net investment income and the limit on his investment interest expense deduction in the following way: Total investment income $10,000 Minus: Investment expenses (other than interest) 3,200 Net investment income $6,800 Deductible investment interest expense for the year $6,800 The $2,000 of income from the passive activity is not used in determining Ted's net investment income. 1040 nrez His investment interest deduction for the year is limited to $6,800, the amount of his net investment income. 1040 nrez Form 4952 Use Form 4952 to figure your deduction for investment interest. 1040 nrez See Form 4952 for more information. 1040 nrez Exception to use of Form 4952. 1040 nrez   You do not have to complete Form 4952 or attach it to your return if you meet all of the following tests. 1040 nrez Your investment interest expense is not more than your investment income from interest and ordinary dividends minus any qualified dividends. 1040 nrez You do not have any other deductible investment expenses. 1040 nrez You have no carryover of investment interest expense from 2012. 1040 nrez   If you meet all of these tests, you can deduct all of your investment interest. 1040 nrez    Bond Premium Amortization If you pay a premium to buy a bond, the premium is part of your basis in the bond. 1040 nrez If the bond yields taxable interest, you can choose to amortize the premium. 1040 nrez This generally means that each year, over the life of the bond, you use a part of the premium to reduce the amount of interest includible in your income. 1040 nrez If you make this choice, you must reduce your basis in the bond by the amortization for the year. 1040 nrez If the bond yields tax-exempt interest, you must amortize the premium. 1040 nrez This amortized amount is not deductible in determining taxable income. 1040 nrez However, each year you must reduce your basis in the bond (and tax-exempt interest otherwise reportable on Form 1040, line 8b) by the amortization for the year. 1040 nrez Bond premium. 1040 nrez   Bond premium is the amount by which your basis in the bond right after you get it is more than the total of all amounts payable on the bond after you get it (other than payments of qualified stated interest). 1040 nrez For example, a bond with a maturity value of $1,000 generally would have a $50 premium if you buy it for $1,050. 1040 nrez Special rules to determine amounts payable on a bond. 1040 nrez   For special rules that apply to determine the amounts payable on a variable rate bond, an inflation-indexed debt instrument, a bond that provides for certain alternative payment schedules (for example, a bond callable prior to the stated maturity date of the bond), or a bond that provides for remote or incidental contingencies, see Regulations section 1. 1040 nrez 171-3. 1040 nrez Basis. 1040 nrez   In general, your basis for figuring bond premium amortization is the same as your basis for figuring any loss on the sale of the bond. 1040 nrez However, you may need to use a different basis for: Convertible bonds, Bonds you got in a trade, and Bonds whose basis has to be determined using the basis of the person who transferred the bond to you. 1040 nrez See Regulations section 1. 1040 nrez 171-1(e). 1040 nrez Dealers. 1040 nrez   A dealer in taxable bonds (or anyone who holds them mainly for sale to customers in the ordinary course of a trade or business or who would properly include bonds in inventory at the close of the tax year) cannot claim a deduction for amortizable bond premium. 1040 nrez   See section 75 of the Internal Revenue Code for the treatment of bond premium by a dealer in tax-exempt bonds. 1040 nrez How To Figure Amortization For bonds issued after September 27, 1985, you must amortize bond premium using a constant yield method on the basis of the bond's yield to maturity, determined by using the bond's basis and compounding at the close of each accrual period. 1040 nrez Constant yield method. 1040 nrez   Figure the bond premium amortization for each accrual period as follows. 1040 nrez Step 1: Determine your yield. 1040 nrez   Your yield is the discount rate that, when used in figuring the present value of all remaining payments to be made on the bond (including payments of qualified stated interest), produces an amount equal to your basis in the bond. 1040 nrez Figure the yield as of the date you got the bond. 1040 nrez It must be constant over the term of the bond and must be figured to at least two decimal places when expressed as a percentage. 1040 nrez   If you do not know the yield, consult your broker or tax advisor. 1040 nrez Databases available to them are likely to show the yield at the date of purchase. 1040 nrez Step 2: Determine the accrual periods. 1040 nrez   You can choose the accrual periods to use. 1040 nrez They may be of any length and may vary in length over the term of the bond, but each accrual period can be no longer than 1 year and each scheduled payment of principal or interest must occur either on the first or the final day of an accrual period. 1040 nrez The computation is simplest if accrual periods are the same as the intervals between interest payment dates. 1040 nrez Step 3: Determine the bond premium for the accrual period. 1040 nrez   To do this, multiply your adjusted acquisition price at the beginning of the accrual period by your yield. 1040 nrez Then subtract the result from the qualified stated interest for the period. 1040 nrez   Your adjusted acquisition price at the beginning of the first accrual period is the same as your basis. 1040 nrez After that, it is your basis decreased by the amount of bond premium amortized for earlier periods and the amount of any payment previously made on the bond other than a payment of qualified stated interest. 1040 nrez Example. 1040 nrez On February 1, 2012, you bought a taxable bond for $110,000. 1040 nrez The bond has a stated principal amount of $100,000, payable at maturity on February 1, 2019, making your premium $10,000 ($110,000 − $100,000). 1040 nrez The bond pays qualified stated interest of $10,000 on February 1 of each year. 1040 nrez Your yield is 8. 1040 nrez 07439% compounded annually. 1040 nrez You choose to use annual accrual periods ending on February 1 of each year. 1040 nrez To find your bond premium amortization for the accrual period ending on February 1, 2013, you multiply the adjusted acquisition price at the beginning of the period ($110,000) by your yield. 1040 nrez When you subtract the result ($8,881. 1040 nrez 83) from the qualified stated interest for the period ($10,000), you find that your bond premium amortization for the period is $1,118. 1040 nrez 17. 1040 nrez Special rules to figure amortization. 1040 nrez   For special rules to figure the bond premium amortization on a variable rate bond, an inflation-indexed debt instrument, a bond that provides for certain alternative payment schedules (for example, a bond callable prior to the stated maturity date of the bond), or a bond that provides for remote or incidental contingencies, see Regulations section 1. 1040 nrez 171-3. 1040 nrez Bonds Issued Before September 28, 1985 For these bonds, you can amortize bond premium using any reasonable method. 1040 nrez Reasonable methods include: The straight-line method, and The Revenue Ruling 82-10 method. 1040 nrez Straight-line method. 1040 nrez   Under this method, the amount of your bond premium amortization is the same each month. 1040 nrez Divide the number of months you held the bond during the year by the number of months from the beginning of the tax year (or, if later, the date of acquisition) to the date of maturity or earlier call date. 1040 nrez Then multiply the result by the bond premium (reduced by any bond premium amortization claimed in earlier years). 1040 nrez This gives you your bond premium amortization for the year. 1040 nrez Revenue Ruling 82-10 method. 1040 nrez   Under this method, the amount of your bond premium amortization increases each month over the life of the bond. 1040 nrez This method is explained in Revenue Ruling 82-10, 1982-1 C. 1040 nrez B. 1040 nrez 46. 1040 nrez Choosing To Amortize You choose to amortize the premium on taxable bonds by reporting the amortization for the year on your income tax return for the first tax year you want the choice to apply. 1040 nrez You should attach a statement to your return that you are making this choice under section 171. 1040 nrez See How To Report Amortization, next. 1040 nrez This choice is binding for the year you make it and for later tax years. 1040 nrez It applies to all taxable bonds you own in the year you make the choice and also to those you acquire in later years. 1040 nrez You can change your decision to amortize bond premium only with the written approval of the IRS. 1040 nrez To request approval, use Form 3115. 1040 nrez For more information on requesting approval, see section 5 of the Appendix to Revenue Procedure 2011-14 in Internal Revenue Bulletin 2011-4. 1040 nrez You can find Revenue Procedure 2011-14 at www. 1040 nrez irs. 1040 nrez gov/irb/2011-04_IRB/ar08. 1040 nrez html. 1040 nrez How To Report Amortization Subtract the bond premium amortization from your interest income from these bonds. 1040 nrez Report the bond's interest on Schedule B (Form 1040A or 1040), line 1. 1040 nrez Under your last entry on line 1, put a subtotal of all interest listed on line 1. 1040 nrez Below this subtotal, print “ABP Adjustment,” and the total interest you received. 1040 nrez Subtract this amount from the subtotal, and enter the result on line 2. 1040 nrez Bond premium amortization more than interest. 1040 nrez   If the amount of your bond premium amortization for an accrual period is more than the qualified stated interest for the period, you can deduct the difference as a miscellaneous itemized deduction on Schedule A (Form 1040), line 28. 1040 nrez    But your deduction is limited to the amount by which your total interest inclusions on the bond in prior accrual periods is more than your total bond premium deductions on the bond in prior periods. 1040 nrez Any amount you cannot deduct because of this limit can be carried forward to the next accrual period. 1040 nrez Pre-1998 election to amortize bond premium. 1040 nrez   Generally, if you first elected to amortize bond premium before 1998, the above treatment of the premium does not apply to bonds you acquired before 1988. 1040 nrez Bonds acquired before October 23, 1986. 1040 nrez   The amortization of the premium on these bonds is a miscellaneous itemized deduction not subject to the 2%-of-adjusted-gross-income limit. 1040 nrez Bonds acquired after October 22, 1986, but before 1988. 1040 nrez    The amortization of the premium on these bonds is investment interest expense subject to the investment interest limit, unless you choose to treat it as an offset to interest income on the bond. 1040 nrez Expenses of Producing Income You deduct investment expenses (other than interest expenses) as miscellaneous itemized deductions on Schedule A (Form 1040). 1040 nrez To be deductible, these expenses must be ordinary and necessary expenses paid or incurred: To produce or collect income, or To manage property held for producing income. 1040 nrez The expenses must be directly related to the income or income-producing property, and the income must be taxable to you. 1040 nrez The deduction for most income-producing expenses is subject to a 2% limit that also applies to certain other miscellaneous itemized deductions. 1040 nrez The amount deductible is limited to the total of these miscellaneous deductions that is more than 2% of your adjusted gross income. 1040 nrez For information on how to report expenses of producing income, see How To Report Investment Expenses , later. 1040 nrez Attorney or accounting fees. 1040 nrez   You can deduct attorney or accounting fees that are necessary to produce or collect taxable income. 1040 nrez However, in some cases, attorney or accounting fees are part of the basis of property. 1040 nrez See Basis of Investment Property in chapter 4. 1040 nrez Automatic investment service and dividend reinvestment plans. 1040 nrez   A bank may offer its checking account customers an automatic investment service so that, for a charge, each customer can choose to invest a part of the checking account each month in common stock. 1040 nrez Or a bank that is a dividend disbursing agent for a number of publicly-owned corporations may set up an automatic dividend reinvestment service. 1040 nrez Through that service, cash dividends are reinvested in more shares of stock after the bank deducts a service charge. 1040 nrez   A corporation in which you own stock also may have a dividend reinvestment plan. 1040 nrez This plan lets you choose to use your dividends to buy more shares of stock in the corporation instead of receiving the dividends in cash. 1040 nrez   You can deduct the monthly service charge you pay to a bank to participate in an automatic investment service. 1040 nrez If you participate in a dividend reinvestment plan, you can deduct any service charge subtracted from your cash dividends before the dividends are used to buy more shares of stock. 1040 nrez Deduct the charges in the year you pay them. 1040 nrez Clerical help and office rent. 1040 nrez   You can deduct office expenses, such as rent and clerical help, you incurred in connection with your investments and collecting the taxable income on your investments. 1040 nrez Cost of replacing missing securities. 1040 nrez   To replace your taxable securities that are mislaid, lost, stolen, or destroyed, you may have to post an indemnity bond. 1040 nrez You can deduct the premium you pay to buy the indemnity bond and the related incidental expenses. 1040 nrez   You may, however, get a refund of part of the bond premium if the missing securities are recovered within a specified time. 1040 nrez Under certain types of insurance policies, you can recover some of the expenses. 1040 nrez   If you receive the refund in the tax year you pay the amounts, you can deduct only the difference between the expenses paid and the amount refunded. 1040 nrez If the refund is made in a later tax year, you must include the refund in income in the year you received it, but only to the extent that the expenses decreased your tax in the year you deducted them. 1040 nrez Fees to collect income. 1040 nrez   You can deduct fees you pay to a broker, bank, trustee, or similar agent to collect investment income, such as your taxable bond or mortgage interest, or your dividends on shares of stock. 1040 nrez Fees to buy or sell. 1040 nrez   You cannot deduct a fee you pay to a broker to acquire investment property, such as stocks or bonds. 1040 nrez You must add the fee to the cost of the property. 1040 nrez See Basis of Investment Property in chapter 4. 1040 nrez    You cannot deduct any broker's fees, commissions, or option premiums you pay (or that were netted out) in connection with the sale of investment property. 1040 nrez They can be used only to figure gain or loss from the sale. 1040 nrez See Reporting Capital Gains and Losses , in chapter 4, for more information about the treatment of these sale expenses. 1040 nrez Investment counsel and advice. 1040 nrez   You can deduct fees you pay for counsel and advice about investments that produce taxable income. 1040 nrez This includes amounts you pay for investment advisory services. 1040 nrez Safe deposit box rent. 1040 nrez   You can deduct rent you pay for a safe deposit box if you use the box to store taxable income-producing stocks, bonds, or other investment-related papers and documents. 1040 nrez If you also use the box to store tax-exempt securities or personal items, you can deduct only part of the rent. 1040 nrez See Tax-exempt income under Nondeductible Expenses, later, to figure what part you can deduct. 1040 nrez State and local transfer taxes. 1040 nrez   You cannot deduct the state and local transfer taxes you pay when you buy or sell securities. 1040 nrez If you pay these transfer taxes when you buy securities, you must treat them as part of the cost of the property. 1040 nrez If you pay these transfer taxes when you sell securities, you must treat them as a reduction in the amount realized. 1040 nrez Trustee's commissions for revocable trust. 1040 nrez   If you set up a revocable trust and have its income distributed to you, you can deduct the commission you pay the trustee for managing the trust to the extent it is to produce or collect taxable income or to manage property. 1040 nrez However, you cannot deduct any part of the commission used for producing or collecting tax-exempt income or for managing property that produces tax-exempt income. 1040 nrez   If you are a cash-basis taxpayer and pay the commissions for several years in advance, you must deduct a part of the commission each year. 1040 nrez You cannot deduct the entire amount in the year you pay it. 1040 nrez Investment expenses from pass-through entities. 1040 nrez   If you hold an interest in a partnership, S corporation, real estate mortgage investment conduit (REMIC), or a nonpublicly offered mutual fund, you can deduct your share of that entity's investment expenses. 1040 nrez A partnership or S corporation will show your share of these expenses on your Schedule K-1 (Form 1065) or Schedule K-1 (Form 1120S). 1040 nrez A nonpublicly offered mutual fund will indicate your share of these expenses in box 5 of Form 1099-DIV (or substitute statement). 1040 nrez Publicly-offered mutual funds are discussed later. 1040 nrez   If you hold an interest in a REMIC, any expenses relating to your residual interest investment will be shown on Schedule Q (Form 1066), line 3b. 1040 nrez Any expenses relating to your regular interest investment will appear in box 5 of Form 1099-INT (or substitute statement) or box 9 of Form 1099-OID (or substitute statement). 1040 nrez   Report your share of these investment expenses on Schedule A (Form 1040), subject to the 2% limit, in the same manner as your other investment expenses. 1040 nrez Including mutual fund or REMIC expenses in income. 1040 nrez   Your share of the investment expenses of a REMIC or a nonpublicly offered mutual fund, as described above, are considered to be indirect deductions through that pass-through entity. 1040 nrez You must include in your gross income an amount equal to the expenses allocated to you, whether or not you are able to claim a deduction for those expenses. 1040 nrez If you are a shareholder in a nonpublicly offered mutual fund, you must include on your return the full amount of ordinary dividends or other distributions of stock, as shown in box 1a of Form 1099-DIV (or substitute statement). 1040 nrez If you are a residual interest holder in a REMIC, you must report as ordinary income on Schedule E (Form 1040) the total amounts shown on Schedule Q (Form 1066), lines 1b and 3b. 1040 nrez If you are a REMIC regular interest holder, you must include the amount of any expense allocation you received on Form 1040, line 8a. 1040 nrez Publicly-offered mutual funds. 1040 nrez   Most mutual funds are publicly offered. 1040 nrez These mutual funds, generally, are traded on an established securities exchange. 1040 nrez These funds do not pass investment expenses through to you. 1040 nrez Instead, the dividend income they report to you in box 1a of Form 1099-DIV (or substitute statement) is already reduced by your share of investment expenses. 1040 nrez As a result, you cannot deduct the expenses on your return. 1040 nrez   Include the amount from box 1a of Form 1099-DIV (or substitute statement) in your income. 1040 nrez    A publicly offered mutual fund is one that: Is continuously offered pursuant to a public offering, Is regularly traded on an established securities market, and Is held by or for no fewer than 500 persons at any time during the year. 1040 nrez Contact your mutual fund if you are not sure whether it is publicly offered. 1040 nrez Nondeductible Expenses Some expenses that you incur as an investor are not deductible. 1040 nrez Stockholders' meetings. 1040 nrez   You cannot deduct transportation and other expenses you pay to attend stockholders' meetings of companies in which you have no interest other than owning stock. 1040 nrez This is true even if your purpose in attending is to get information that would be useful in making further investments. 1040 nrez Investment-related seminar. 1040 nrez   You cannot deduct expenses for attending a convention, seminar, or similar meeting for investment purposes. 1040 nrez Single-premium life insurance, endowment, and annuity contracts. 1040 nrez   You cannot deduct interest on money you borrow to buy or carry a single-premium life insurance, endowment, or annuity contract. 1040 nrez Used as collateral. 1040 nrez   If you use a single premium annuity contract as collateral to obtain or continue a mortgage loan, you cannot deduct any interest on the loan that is collateralized by the annuity contract. 1040 nrez Figure the amount of interest expense disallowed by multiplying the current interest rate on the mortgage loan by the lesser of the amount of the annuity contract used as collateral or the amount of the loan. 1040 nrez Borrowing on insurance. 1040 nrez   Generally, you cannot deduct interest on money you borrow to buy or carry a life insurance, endowment, or annuity contract if you plan to systematically borrow part or all of the increases in the cash value of the contract. 1040 nrez This rule applies to the interest on the total amount borrowed to buy or carry the contract, not just the interest on the borrowed increases in the cash value. 1040 nrez Tax-exempt income. 1040 nrez   You cannot deduct expenses you incur to produce tax-exempt income. 1040 nrez Nor can you deduct interest on money you borrow to buy tax-exempt securities or shares in a mutual fund or other regulated investment company that distributes only exempt-interest dividends. 1040 nrez Short-sale expenses. 1040 nrez   The rule disallowing a deduction for interest expenses on tax-exempt securities applies to amounts you pay in connection with personal property used in a short sale or amounts paid by others for the use of any collateral in connection with the short sale. 1040 nrez However, it does not apply to the expenses you incur if you deposit cash as collateral for the property used in the short sale and the cash does not earn a material return during the period of the sale. 1040 nrez Short sales are discussed in Short Sales in chapter 4. 1040 nrez Expenses for both tax-exempt and taxable income. 1040 nrez   You may have expenses that are for both tax-exempt and taxable income. 1040 nrez If you cannot specifically identify what part of the expenses is for each type of income, you can divide the expenses, using reasonable proportions based on facts and circumstances. 1040 nrez You must attach a statement to your return showing how you divided the expenses and stating that each deduction claimed is not based on tax-exempt income. 1040 nrez   One accepted method for dividing expenses is to do it in the same proportion that each type of income is to the total income. 1040 nrez If the expenses relate in part to capital gains and losses, include the gains, but not the losses, in figuring this proportion. 1040 nrez To find the part of the expenses that is for the tax-exempt income, divide your tax-exempt income by the total income and multiply your expenses by the result. 1040 nrez Example. 1040 nrez You received $6,000 interest; $4,800 was tax-exempt and $1,200 was taxable. 1040 nrez In earning this income, you had $500 of expenses. 1040 nrez You cannot specifically identify the amount of each expense item that is for each income item, so you must divide your expenses. 1040 nrez 80% ($4,800 tax-exempt interest divided by $6,000 total interest) of your expenses is for the tax-exempt income. 1040 nrez You cannot deduct $400 (80% of $500) of the expenses. 1040 nrez You can deduct $100 (the rest of the expenses) because they are for the taxable interest. 1040 nrez State income taxes. 1040 nrez   If you itemize your deductions, you can deduct, as taxes, state income taxes on interest income that is exempt from federal income tax. 1040 nrez But you cannot deduct, as either taxes or investment expenses, state income taxes on other exempt income. 1040 nrez Interest expense and carrying charges on straddles. 1040 nrez   You cannot deduct interest and carrying charges allocable to personal property that is part of a straddle. 1040 nrez The nondeductible interest and carrying charges are added to the basis of the straddle property. 1040 nrez However, this treatment does not apply if: All the offsetting positions making up the straddle either consist of one or more qualified covered call options and the optioned stock, or consist of section 1256 contracts (and the straddle is not part of a larger straddle); or The straddle is a hedging transaction. 1040 nrez  For information about straddles, including definitions of the terms used in this discussion, see Straddles in chapter 4. 1040 nrez   Interest includes any amount you pay or incur in connection with personal property used in a short sale. 1040 nrez However, you must first apply the rules discussed in Payments in lieu of dividends under Short Sales in chapter 4. 1040 nrez   To determine the interest on market discount bonds and short-term obligations that are part of a straddle, you must first apply the rules discussed under Limit on interest deduction for market discount bonds and Limit on interest deduction for short-term obligations (both under Interest Expenses, earlier). 1040 nrez Nondeductible amount. 1040 nrez   Figure the nondeductible interest and carrying charges on straddle property as follows. 1040 nrez Add: Interest on indebtedness incurred or continued to buy or carry the personal property, and All other amounts (including charges to insure, store, or transport the personal property) paid or incurred to carry the personal property. 1040 nrez Subtract from the amount in (1): Interest (including OID) includible in gross income for the year on the personal property, Any income from the personal property treated as ordinary income on the disposition of short-term government obligations or as ordinary income under the market discount and short-term bond provisions — see Discount on Debt Instruments in chapter 1, The dividends includible in gross income for the year from the personal property, and Any payment on a loan of the personal property for use in a short sale that is includible in gross income. 1040 nrez Basis adjustment. 1040 nrez   Add the nondeductible amount to the basis of your straddle property. 1040 nrez How To Report Investment Expenses To deduct your investment expenses, you must itemize deductions on Schedule A (Form 1040). 1040 nrez Enter your deductible investment interest expense on Schedule A (Form1040), line 14. 1040 nrez Include any deductible short sale expenses. 1040 nrez (See Short Sales in chapter 4 for information on these expenses. 1040 nrez ) Also attach a completed Form 4952 if you used that form to figure your investment interest expense. 1040 nrez Enter the total amount of your other investment expenses (other than interest expenses) on Schedule A (Form 1040), line 23. 1040 nrez List the type and amount of each expense on the dotted lines next to line 23. 1040 nrez (If necessary, you can show the required information on an attached statement. 1040 nrez ) For information on how to report amortizable bond premium, see Bond Premium Amortization , earlier in this chapter. 1040 nrez When To Report Investment Expenses If you use the cash method to report income and expenses, you generally deduct your expenses, except for certain prepaid interest, in the year you pay them. 1040 nrez If you use an accrual method, you generally deduct your expenses when you incur a liability for them, rather than when you pay them. 1040 nrez Also see When To Deduct Investment Interest , earlier in this chapter. 1040 nrez Unpaid expenses owed to related party. 1040 nrez   If you use an accrual method, you cannot deduct interest and other expenses owed to a related cash-basis person until payment is made and the amount is includible in the gross income of that person. 1040 nrez The relationship, for purposes of this rule, is determined as of the end of the tax year for which the interest or expense would otherwise be deductible. 1040 nrez If a deduction is denied under this rule, this rule will continue to apply even if your relationship with the person ceases to exist before the amount is includible in the gross income of that person. 1040 nrez   This rule generally applies to those relationships listed in chapter 4 under Related Party Transactions . 1040 nrez It also applies to accruals by partnerships to partners, partners to partnerships, shareholders to S corporations, and S corporations to shareholders. 1040 nrez   The postponement of deductions for unpaid expenses and interest under the related party rule does not apply to OID, regardless of when payment is made. 1040 nrez This rule also does not apply to loans with below-market interest rates or to certain payments for the use of property and services when the lender or recipient has to include payments periodically in income, even if a payment has not been made. 1040 nrez Prev  Up  Next   Home   More Online Publications