Investment interest — interest on debt used to buy assets held for investment—is usually deductible for both regular tax and alternative minimum tax purposes, but certain rules apply that can make this itemized deduction less beneficial.

Whether you can deduct investment interest, how you can deduct it, and when you can deduct it is can be determined by the limits of the deduction and tax treatment.

Limits on the Deduction
First off, you can’t deduct interest you incurred to produce tax-exempt income. For example, if you borrowed money to invest in municipal bonds, which are exempt from federal income tax, you can’t deduct the interest.

Furthermore, and perhaps most significant, your investment interest deduction is limited to your net investment income, which, for this deduction, generally includes taxable interest, nonqualified dividends, and net short-term capital gains, reduced by other investment expenses. In other words, long-term capital gains and qualified dividends aren’t included.

However, any disallowed interest is carried forward. You can then deduct the disallowed interest in a later year if you have excess net investment income.

Changing the Tax Treatment
You may elect to treat net long-term capital gains or qualified dividends as investment income to deduct more of your investment interest. But if you do, that portion of the long-term capital gain or dividend will be taxed at ordinary-income rates.

If you’re contemplating whether you can claim the investment interest expense deduction on your 2016 return, please contact your advisor calculate your potential deduction or to determine whether you could benefit from treating gains or dividends differently to maximize your deduction.