The Investment Interest Limitation Under the Tax Reform Act of 1986
| Publication year | 1987 |
| Pages | 36 |
1987, January, Pg. 36. The Investment Interest Limitation Under the Tax Reform Act of 1986
The Tax Reform Act of 1986 ("Tax Reform Act")(fn1) continues the trend of recent tax legislation by chipping away at the interest deduction which was, to much of the public and the tax bar, a pillar of the Internal Revenue Code of 1954 as amended ("Code"). The most notable of the changes are the new passive loss rules and the elimination of the deduction for personal interest. The modifications to the investment interest limitations under new Code § 163(d) have received less notice.
Viewed in isolation, the changes to § 163(d) appear to do little more than tinker with the existing rules. Investment interest deductions are further restricted, but the basic structure is retained. However, the changes are better understood as part of a larger overhaul of the interest deduction rules. Investment interest, along with personal interest and interest from passive activities, is now one of several categories of interest expenditures, each of which is subject to separate rules. The result is kaleidoscopic---a taxpayer planning to incur or restructure debt must consider an array of alternatives.
This column discusses the new investment interest rules. Its purpose is not to provide a detailed technical analysis, but to place new § 163(d) in the context of the new interest rules. The first section outlines the categories of interest that exist following the Tax Reform Act and summarizes the major changes to the investment interest rules. Subsequent sections explore the definitions employed to implement the new rules.
Prior to the Tax Reform Act, interest expenditures could be divided into three primary categories: (1) investment interest which was deductible subject to limitations; (2) interest expense (e.g., construction interest), capitalized under other provisions of the Code; and (3) all other interest which was generally deductible.
The Tax Reform Act divides the investment interest category into four new subcategories: (1) interest incurred in a trade or business in which the taxpayer materially participates, which is generally deductible; (2) interest attributable to passive activities (e.g., a trade or business without material participation), which is subject to the passive loss restrictions under new Code § 469; (3) qualified residence interest, which generally is attributable to indebtedness secured by the taxpayer's primary or second residence, subject to certain limitations, and is deductible; and (4) non-deductible personal interest. Regarding the passive loss rules, it is important to note that passive losses cannot be used to offset portfolio (investment) income.(fn2)
The Tax Reform Act made two primary changes to § 163(d). First, the deduction for investment interest is limited to net investment income.(fn3) Under prior law, the taxpayer was permitted to deduct the following: investment interest in an amount equal to the sum of net investment income, $10,000 (or $5,000 for married...
To continue reading
Request your trial