Answers to your Tax Planning Questions

I have an aunt who many years ago inherited a lot which was then worth $90,000. She wants to sell it to me for much less so I can build a home. Can she do this without a problem, or is she somehow prohibited from selling it to me cheaper? T.C. via e-mail

There is no restriction on the amount for which you aunt can sell you the property. There are rules that prevent people from deducting a loss on such a sale when the sale is made to certain relatives, but the relationship of aunt and niece or nephew is exempt from these rules.  

Thus your aunt may sell you the property for less than her basis (which is the value of the property at the time of the inheritance), and your purchase price will become your basis in the property.

Are margin loans a deductible item on my tax return? D.M. via e-mail

You'd think there would be a simple answer to this question. But we're talking about tax laws here, and there's no such thing as a simple answer in the land of tax laws.  

First, the margin loan itself is not a deductible item. Just as you would borrow money for a car or any other purchase, the amount that you borrow is money that you have to pay back and is not yours in the first place, thus it is not yours to deduct.  

The interest on the margin loan account is another story. Interest on margin accounts is interest paid in order to borrow money to invest, and this type of interest is usually tax deductible, with a couple of stipulations.

• The margin money must be invested in taxable securities. For example, if you invest in tax-free municipal bonds, the interest on the loan account is not deductible. If part of the margin loan is invested in taxable securities and part in tax-free securities, you should prorate the amount of the interest and determine how much is related to taxable investments.

• The other concern about deducting margin interest is that this interest is classified as investment interest. The amount of investment interest you can deduct is limited to the amount of investment income on which you pay income tax.  

Investment income includes dividends, interest, annuities, and royalties. If you want, you can include net gains from the sale of your investments in your investment income in order to get your investment income high enough to enable you to deduct the investment interest. By net gain, I mean the amount by which your total gains exceed your losses from sales of investments.  

But watch out! If you choose to include net gains from the sale of investments (called capital gains) as part of the investment income that offsets your margin interest, you will be barred from using the lower capital gain tax rate as your tax on these gains.  

Here are some examples.

• Example 1: Say you paid $500 in interest on your margin account during the year. Your taxable interest and dividend income total $750 for the year. You can deduct all of your margin interest as an itemized deduction on your Schedule A. Obviously, you must be able to itemize deductions in order to deduct your investment interest expense.

• Example 2: Once again, your margin interest is $500. Your interest and dividend income for the year is only $300 and you have no capital gain income. You can only deduct $300 of your margin interest as an itemized deduction. The remaining $200 can be carried over, and you can try to deduct it (if you have offsetting investment income) in future years.

• Example 3: Once again, your margin interest is $500. Your interest and dividend income totals $300. You also have $600 net capital gain income on your Schedule D from the sale of some stocks. You can deduct the first $300 of your margin interest as an itemized deduction because it offsets the $300 dividend and interest income.

You can also deduct the remaining $200 margin interest as an itemized deduction if you are willing to forego the capital gain tax rate on $200 of your $600 capital gain income. If you do this, $200 of your capital gain income will be taxed at your normal income tax rate, and the remaining $400 of your capital gain income will be taxed at the lower capital gain tax rates.  

Alternatively, you can choose to carry over the $200 margin interest to next year and use the capital gain tax rates on all of your net capital gain income in the current year.