Question

George recently received a great stock tip from his friend, Mason. George didn’t have any cash on hand to invest, so he decided to take out a $41,000 loan to facilitate the stock acquisition. The loan terms are 8 percent interest with interest-only payments due each year for five years. At the end of the five-year period the entire loan principal is due. When George closed on the loan on April 1, 2020, he decided to invest $24,600 in stock and to use the remaining $16,400 to purchase a four-wheel recreation vehicle. George is unsure how he will treat the interest paid on the $41,000 loan. In 2020, George paid $2,460 interest expense on the loan. (Hint: Visit https://www.irs.gov/ and consider IRS Publication 550.)

What amount may he deduct as interest in 2020?

Answer 1

As per the provision of IRS (reference to 550), any amount of interest due towards money borrowed for investment purposes (also known as investment interest) can be claimed as a deduction. Therefore, it becomes important to allocate the total amount of loan/borrowing between the amount utilized for personal/business purposes and investment purposes.

In the given case, George has borrowed $41,000, out of which $24,600 has been used for investment purposes, that is, 60% (24,600/41,000*100%), while the remaining 40% (16,400/41,000*100) is used for personal purposes (purchase of four-wheel recreation vehicle).

Therefore, out of the total interest of $2460 (41,000*8%*9/12) due on the amount borrowed, $1476 (2,460*60%) can be claimed as deduction (in the form of investment interest). The remaining $984 cannot be claimed as deduction.

Answer is $1,476.