Interest on a Loan Management Account is tax deductible only when you can trace the borrowed money to a qualifying use, and how much you can deduct depends on which use that is. The IRS does not treat an LMA specially because a brokerage portfolio secures it. What matters is where the dollars went: into investments, into a business, into a passive activity, or into personal spending. Each answer sits in a different part of the code with its own cap.
Tracing Decides Everything
Under the temporary Treasury regulations on interest allocation, interest expense follows the expenditure the borrowed money paid for, not the collateral behind the loan.1GovInfo. 26 CFR 1.163-8T Allocation of Interest Expense Among Expenditures Borrow $100,000 from your LMA and buy corporate bonds, and the interest is investment interest. Send that same $100,000 into your sole proprietorship, and it becomes business interest. Spend it on a kitchen renovation and it is personal interest, which is not deductible at all. A single LMA can generate two or three categories of interest at once if you split the proceeds among different uses.
Commingling is where taxpayers lose the deduction. If LMA proceeds land in a checking account that already holds other money, the tracing rules deem the borrowed funds spent on the first expenditures made from that account, whatever those happen to be. The safer approach is a dedicated account: move the proceeds in, make each qualifying purchase directly from it, and keep the paper trail intact.
Investment Use: Deductible Up to Net Investment Income
Most people who borrow against a brokerage account use the money to buy more securities. That puts the interest into the investment interest category, which is deductible only up to your net investment income for the year.2Office of the Law Revision Counsel. 26 USC 163 – Interest Anything above the cap is disallowed for the current year.
Net investment income generally means your investment income minus your investment expenses other than interest. Investment income includes taxable interest, non-qualified dividends, short-term capital gains, and royalties from investment property.3Internal Revenue Service. Publication 550 – Investment Income and Expenses Under current law, most investment expenses beyond interest are no longer separately deductible, so for most taxpayers net investment income effectively equals investment income.
Long-term capital gains and qualified dividends are excluded from that calculation by default because they get preferential tax rates. This is where the arithmetic often disappoints: a portfolio can throw off substantial gains and still leave you with a small net investment income figure, which shrinks the LMA interest you can actually deduct.
Electing to Pull Capital Gains Into the Cap
You can elect to treat some or all of your net long-term capital gains and qualified dividends as investment income, which raises the ceiling on your deductible interest.2Office of the Law Revision Counsel. 26 USC 163 – Interest Any amount you reclassify loses its preferential rate and gets taxed as ordinary income instead.3Internal Revenue Service. Publication 550 – Investment Income and Expenses
The trade-off is arithmetic. Compare the tax you save by deducting more interest against the extra tax you owe by taxing capital gains at your ordinary rate (which can reach 37%) rather than the 15% or 20% capital gains rate. For lower-bracket filers the election sometimes pays. For anyone already at the top rate, surrendering the preferential rate rarely comes out ahead. You make the election on Form 4952 and it applies only for the year filed.
What Happens to the Disallowed Portion
Investment interest you cannot deduct this year carries forward indefinitely. In the following year it is treated as investment interest paid that year and stays subject to the same net investment income cap.2Office of the Law Revision Counsel. 26 USC 163 – Interest As investment income grows, the carryforward gets used up. You are responsible for tracking the balance across years.
Business Use: A Cleaner Deduction
LMA interest traced to a trade or business is business interest, reported on the appropriate business schedule such as Schedule C for a sole proprietor, and it reduces business income directly.4Internal Revenue Service. Topic No. 505 Interest Expense It is not an itemized deduction, so you get it whether or not you itemize, and it is not subject to the net investment income cap.
Business interest has its own limit. It is generally capped at business interest income plus 30% of adjusted taxable income for the year.2Office of the Law Revision Counsel. 26 USC 163 – Interest Businesses with average annual gross receipts under an inflation-adjusted threshold, roughly $30 million to $32 million in recent years, are exempt from this cap. Most individuals funding a small business with LMA proceeds are nowhere near that threshold, so the cap rarely bites.
Passive Activity Use: Own Silo, Own Rules
If LMA proceeds fund a passive activity, such as a rental property or a limited partnership in which you do not materially participate, the interest is neither investment interest nor business interest. It lives inside the passive activity loss rules and can only offset passive activity income.5Office of the Law Revision Counsel. 26 USC 469 – Passive Activity Losses and Credits Limited The investment interest rules explicitly exclude passive activity income and expenses, so you cannot fold this interest into your Form 4952 calculation.2Office of the Law Revision Counsel. 26 USC 163 – Interest
Rental real estate has a narrow exception. If you actively participate in managing the property, you can deduct up to $25,000 of passive losses, allocable interest included, against non-passive income each year.5Office of the Law Revision Counsel. 26 USC 469 – Passive Activity Losses and Credits Limited That allowance phases out at higher income levels. Losses you cannot use carry forward until you have passive income or fully dispose of the activity.
When the Interest Is Not Deductible at All
Two uses shut the deduction down entirely. The first is personal spending. The tax code disallows any deduction for personal interest, meaning interest that does not fall into one of the recognized categories such as investment, business, passive activity, qualified mortgage, or student loan interest.2Office of the Law Revision Counsel. 26 USC 163 – Interest LMA proceeds spent on a vacation, a personal car, or household expenses produce interest with no tax offset.
The second is tax-exempt securities. Interest on debt incurred to purchase or carry municipal bonds and other tax-exempt obligations is fully non-deductible.6Office of the Law Revision Counsel. 26 USC 265 – Expenses and Interest Relating to Tax-Exempt Income You cannot claim a deduction for the cost of earning income that itself escapes federal tax. This trips up investors who hold taxable bonds and munis in the same account and borrow against the combined portfolio.
Claiming the Deduction on Your Return
For qualifying investment interest, you file Form 4952 to calculate the deductible amount.7Internal Revenue Service. Form 4952 – Investment Interest Expense Deduction The form works through your total investment interest expense, your net investment income (including any election to reclassify capital gains), and the resulting deductible figure plus any carryforward. The deductible amount flows to Schedule A, Line 9, as an itemized deduction. If your interest and ordinary dividend income already exceed your investment interest expense, you have no prior-year carryforward, and no other deductible investment expenses, you can skip Form 4952 and put the amount straight on Schedule A.3Internal Revenue Service. Publication 550 – Investment Income and Expenses
Because the investment interest deduction is itemized, it only helps in a year your itemized deductions exceed the standard deduction, which for 2026 is $16,100 for single filers and $32,200 for joint filers.8Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026 If your itemizable expenses do not clear the standard deduction, the interest gives you nothing this year. It still carries forward, so it is not gone.
Your brokerage will report total LMA or margin interest paid on your year-end consolidated statement. Proving the use of proceeds is on you. Keep the disbursement date, the account the money moved into, and the specific asset or expense it funded. If proceeds ever passed through a commingled account, document the sequence and timing of the withdrawals. Without that trail, the IRS will treat the interest as personal and deny the deduction.