J.K. Lasser's Your Income Tax 2013: For Preparing Your 2012 Tax Return

15.10 Investment Interest Limitations

Interest paid on margin accounts and debts to buy or carry other investments is deductible on Schedule A up to the amount of net investment income. If you do not have investment income such as interest, you may not deduct investment interest. Investment income for purposes of the deduction generally does not include net capital gains or qualified dividends, but you may elect to include them in order to increase your investment interest deduction. If you make the election, the elected amount will not be eligible for the favorable capital gain rates; see “Computing the Deduction” below. Investment interest in excess of net investment income may be carried forward and deducted from next year’s net investment income.

You compute the deduction for investment interest on Form 4952, which must be attached along with Schedule A to Form 1040.

What is investment interest?

It is all interest paid or accrued on debts incurred or continued to buy or carry investment property such as interest on securities in a margin account. However, interest on loans to buy tax-exempt securities is not deductible (15.11).

Investment interest does not include interest on qualifying home acquisition debt (15.2) or home equity debt (15.3), production period interest that is capitalized (16.4), or interest related to a passive activity (10.8).

Investment property includes property producing portfolio income (interest, dividends, or royalties not realized in the ordinary course ...