Dear Tax Talk,
Can disallowed investment interest expenses from a deceased taxpayer be carried forward by the spouse next year, or it is lost when a taxpayer dies?
— Matt
Dear Matt,
Interest borrowed for purposes of making investments that are not rental activities is considered investment interest expense, or IIE. Interest paid on a margin account is a typical example. Investment interest expense is deductible only to the extent of investment income. Any IIE in excess of this limit is carried forward to a future year to be offset against investment income in that year.
Investment income is typically interest, dividends (but not qualified dividends taxed at the lower rate) and short-term capital gains. Qualified dividends and long-term capital gains can be treated as investment income if the taxpayer elects to forgo their preferential tax rate. Form 4952 is used to report investment interest expense.
Usually a married couple figures their income and deductions jointly. If the investment interest arose from a joint account, then it is equally each spouse’s loss. The surviving spouse can only carry forward the portion that arose from joint ownership (one-half) plus that IIE from the surviving spouse’s separate property. The IIE of the decedent spouse is not eligible for carry-over. In lieu of the carry-over, the decedent’s assets are stepped up to date of death value, except for deaths in 2010, under certain limited circumstances.
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